Book reviews
Data Mining in Finance: Advances in Relation-
al and Hybrid Methods, Boris Kovalerchuk and
Evgenii Vityaev, Kluwer Academic Publishers,
Norwell, Massachusetts, 2000, ISBN 0-7923-
7804-0, US $120 (Hardback)
As the title suggests, this book acquaints the
reader with data mining methods useful for
financial forecasting. It is an important text
given the incredible challenge represented by
the forecasting of financial time series and is
particularly insightful to those interested in
using data mining to identify market trends.
Rather than attempt to deal with efficient market
theory, the book draws upon the empirical
evidence that short-term, local conditional reg-
ularities may exist. And thus, a primary objec-
tive of the text that the authors successfully
achieve is to illustrate that the financial fore-
casting benefits from relational data mining
based on symbolic methods.
Kovalerchuk and Vityaev take an innovative
approach of or to selecting a single financial
forecasting problem. They focus on forecasting
the stock market; and within this context, they
analyze the strengths and weaknesses of various
forecasting techniques. Within such a context, it
is clear that the forecaster is more concerned
with trading performance based on identified
trading ‘‘rules’’ as compared with the accuracy
of the forecast. Thus, forecasting itself need not
be the final product of the data mining exercise.
The weakness of such an approach is that
different forecasting methods may be superior
depending upon the limitations of the under-
lying financial problem. Fortunately, the authors
do present a smattering of practical examples
that might appeal to forecasters concerned with
alternative problems in finance, such as ex-
change rates and stock ratings.
Following an introductory chapter, the book
is loosely structured into two complementary
sections. Chapters 2–4 focus on describing
specific data mining techniques. The text pro-
155
gresses from numerical data mining to rule-
based methods and finally to relational data
mining. Chapters 2 and 3 do not provide as
great a depth into each topic as Chapter 4 given
that relational data mining techniques are the
focus of the text. Chapters 5–6 analyze specific
financial applications and compare methods
using the same underlying forecasting problem.
The book concludes in Chapter 7 with an
introduction to hybrid models that incorporate
fuzzy logic and applications of such models in
finance.
Chapter 2 presents numerical data mining
models, such as statistical models and neural
networks. The authors discuss the value of
‘‘expert mining’’ as a source of regularities
when dealing with absent or insufficient data. A
typical problem with expert-based learning sys-
tems in finance is the slowness of response of
the systems to changing markets. Kovalerchuk
and Vityaev provide the example of that few
trading rules are successful across different
markets. (this sentence lost me?) Therefore,
much of the chapter is devoted to methods for
mining regularities from an expert’ s perspective
in an expeditious, efficient manner.
Chapter 3 focuses on rule-based and hybrid
data mining, such as decision trees. Although
learned decision trees provide a set of human
readable, consistent rules, they suffer from the
difficulty of discovering small trees for complex
problems. In addition, they fail to compare two
attribute values as is possible with relational
methods. Such solutions are more amenable to
human comprehension than the neural network
approach. Kovalerchuk and Vityaev also discuss
hybrid methods that allow for the extraction of
symbolic representations (rule-based ap-
proaches) from a trained neural network. This
hybrid methodology allows for the combination
of both discoveries in an understandable man-
ner.
Chapter 4 provides an in-depth review of
relational data mining, the primary focus of the
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book. Although there are many relational data
mining algorithms, the field is migrating toward
probabilistic first-order rules to avoid the limita-
tions of deterministic systems. As well as
introducing us to alternative algorithms,
Kovalerchuk and Vityaev detail the Machine
Method for Discovering Regularities (MMDR).
MMDR is well suited to financial applications
given its ability to handle numerical data with
high levels of noise.
Chapter 5 is of particular interest to those
concerned with the success of relational data
mining when applied to financial problems. The
authors reveal how regularities in time series
can be discovered using mathematical logic and
probability theory.
Chapter 6 provides an important comparison
of the performance of relational data mining
methods with other forecasting methods. It is
interesting to note that trading strategies de-
veloped based on MMDR consistently outper-
form trading strategies developed based on
other data-mining methods. And even though
buy and hold can outperform the MMDR-based
trading strategies in a linear growth market,
such strategies appear to perform almost as
well. MMDR-based strategies are clearly su-
perior in volatile markets with changing trends.
A potential weakness of the chapter is the lack
of discussion of the impact of trading fees on
performance. Nevertheless, given the growing
number of portfolio managers using such fore-
casting tools, it appears that relational data
mining algorithms hold a good deal of promise
for the future.
The final Chapter 7 focuses on fuzzy logic
tools. Such knowledge discovery allows for
reductions in the search space given the mining
of knowledge from experts and is thus quite
useful in situations in which the forecaster has
limited training data. Kovalerchuk and Vityaev
discuss the benefits of combining fuzzy logic
with other methods to mitigate weaknesses in
Book reviews
other methods. For example, in a hybrid model,
fuzzy logic might be used to adjust the inputs
and parameters of the neural networks based on
expert information. The authors illustrate the
development of a hybrid model that combines
fuzzy logic with neural networks, but they are
quick to note that fuzzy logic can be combined
into a hybrid system with other data mining
tools. They also present a number of successful
applications of fuzzy logic in finance, including
investment fund management and bond rating
programs.
‘‘Data Mining in Finance’’ is a timely book
that provides an introduction to forecasting
financial time series using data mining. The
weaknesses of the book are primarily structural.
It suffers to some degree from a lack of editing
and at times inundates the reader with terminol-
ogy. In addition, comprehension of the material
would be facilitated by organizing the material
in a more integrated manner, such as the
inclusion of a summary section at the end of
each chapter. In contrast, a wonderful strength
of the book is that it provides insightful com-
parisons of many data mining techniques. Over-
all, it provides excellent examples and argu-
ments for the application of relational data
mining to financial problems and leaves the
reader with expectations of great advancements
in this field in the near future.
Adrian M. Cowan
Senior Financial Economist
U.S. Department of the Treasury
OTS
Office of Risk and Economic Analysis
Washington, DC
USA
PII: S0169-2070( 01 )00128-5