Stock Market Crisis Forecasting Using Neural Networks with Input Factor Selection

Abstract

Artificial neural networks have gained increasing importance in many fields, including quantitative finance, due to their ability to identify, learn and regenerate non-linear relationships between targets of investigation. We explore the potential of artificial neural networks in forecasting financial crises with micro-, macroeconomic and financial factors. In this application of neural networks, a huge amount of available input factors, but limited historical data, often leads to over-parameterized and unstable models. Therefore, we develop an input variable reduction method for model selection. With an iterative walk-forward forecasting and testing procedure, we create out-of-sample predictions for crisis periods of the S&P 500 and demonstrate that the model selected with our method outperforms a model with a set of input factors taken from the literature.