Advances in Financial Machine Learning

CHAPTER 1 Financial Machine Learning as a Distinct Subject

1.1 Motivation

Machine learning (ML) is changing virtually every aspect of our lives. Today ML algorithms accomplish tasks that until recently only expert humans could perform. As it relates to finance, this is the most exciting time to adopt a disruptive technology that will transform how everyone invests for generations. This book explains scientifically sound ML tools that have worked for me over the course of two decades, and have helped me to manage large pools of funds for some of the most demanding institutional investors.

Books about investments largely fall in one of two categories. On one hand we find books written by authors who have not practiced what they teach. They contain extremely elegant mathematics that describes a world that does not exist. Just because a theorem is true in a logical sense does not mean it is true in a physical sense. On the other hand we find books written by authors who offer explanations absent of any rigorous academic theory. They misuse mathematical tools to describe actual observations. Their models are overfit and fail when implemented. Academic investigation and publication are divorced from practical application to financial markets, and many applications in the trading/investment world are not grounded in proper science.

A first motivation for writing this book is to cross the proverbial divide that separates academia and the industry. I have been on both sides of the rift, ...