Friday, August 19, 2022

Complexity in Prediction

Really glad to see that Kelly et al. are keeping at it, moving well into the "double dip" zone and adding regularization.

 The Virtue of Complexity in Return Prediction (2022)

Bryan T. KellySemyon MalamudKangying Zhou

The extant literature predicts market returns with “simple” models that use only a few parameters. Contrary to conventional wisdom, we theoretically prove that simple models severely understate return predictability compared to “complex” models in which the number of parameters exceeds the number of observations. We empirically document the virtue of complexity in US equity market return prediction. Our findings establish the rationale for modeling expected returns through machine learning.

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