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Deep Recurrent Factor Model: Interpretable Non-Linear and Time-Varying Multi-Factor Model

Author

Listed:
  • Kei Nakagawa
  • Tomoki Ito
  • Masaya Abe
  • Kiyoshi Izumi

Abstract

A linear multi-factor model is one of the most important tools in equity portfolio management. The linear multi-factor models are widely used because they can be easily interpreted. However, financial markets are not linear and their accuracy is limited. Recently, deep learning methods were proposed to predict stock return in terms of the multi-factor model. Although these methods perform quite well, they have significant disadvantages such as a lack of transparency and limitations in the interpretability of the prediction. It is thus difficult for institutional investors to use black-box-type machine learning techniques in actual investment practice because they should show accountability to their customers. Consequently, the solution we propose is based on LSTM with LRP. Specifically, we extend the linear multi-factor model to be non-linear and time-varying with LSTM. Then, we approximate and linearize the learned LSTM models by LRP. We call this LSTM+LRP model a deep recurrent factor model. Finally, we perform an empirical analysis of the Japanese stock market and show that our recurrent model has better predictive capability than the traditional linear model and fully-connected deep learning methods.

Suggested Citation

  • Kei Nakagawa & Tomoki Ito & Masaya Abe & Kiyoshi Izumi, 2019. "Deep Recurrent Factor Model: Interpretable Non-Linear and Time-Varying Multi-Factor Model," Papers 1901.11493, arXiv.org.
  • Handle: RePEc:arx:papers:1901.11493
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    References listed on IDEAS

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    Cited by:

    1. Samuel N. Cohen & Derek Snow & Lukasz Szpruch, 2021. "Black-box model risk in finance," Papers 2102.04757, arXiv.org.
    2. Zikai Wei & Bo Dai & Dahua Lin, 2022. "Factor Investing with a Deep Multi-Factor Model," Papers 2210.12462, arXiv.org.
    3. Sang Il Lee & Seong Joon Yoo, 2019. "Multimodal Deep Learning for Finance: Integrating and Forecasting International Stock Markets," Papers 1903.06478, arXiv.org, revised Sep 2019.
    4. Yusuke Uchiyama & Kei Nakagawa, 2020. "TPLVM: Portfolio Construction by Student's $t$-process Latent Variable Model," Papers 2002.06243, arXiv.org.
    5. Zikai Wei & Bo Dai & Dahua Lin, 2023. "E2EAI: End-to-End Deep Learning Framework for Active Investing," Papers 2305.16364, arXiv.org.
    6. Yusuke Uchiyama & Kei Nakagawa, 2020. "TPLVM: Portfolio Construction by Student’s t -Process Latent Variable Model," Mathematics, MDPI, vol. 8(3), pages 1-10, March.
    7. Sang Il Lee, 2020. "Deeply Equal-Weighted Subset Portfolios," Papers 2006.14402, arXiv.org.

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