CRISIS ALERT:Forecasting Stock Market Crisis Events Using Machine Learning Methods

TL;DR

This paper explores machine learning techniques, specifically Random Forest and Extreme Gradient Boosting, to forecast stock market crises in the US, aiming for early detection to prevent economic downturns.

Contribution

It compares the performance of advanced machine learning models for predicting US stock market crashes using comprehensive financial data.

Findings

Extreme Gradient Boosting outperforms Random Forest in crisis prediction

Models achieve high accuracy with 75 financial indicators

Early warning signals can be identified using these methods

Abstract

Historically, the economic recession often came abruptly and disastrously. For instance, during the 2008 financial crisis, the SP 500 fell 46 percent from October 2007 to March 2009. If we could detect the signals of the crisis earlier, we could have taken preventive measures. Therefore, driven by such motivation, we use advanced machine learning techniques, including Random Forest and Extreme Gradient Boosting, to predict any potential market crashes mainly in the US market. Also, we would like to compare the performance of these methods and examine which model is better for forecasting US stock market crashes. We apply our models on the daily financial market data, which tend to be more responsive with higher reporting frequencies. We consider 75 explanatory variables, including general US stock market indexes, SP 500 sector indexes, as well as market indicators that can be used for the purpose of crisis prediction. Finally, we conclude, with selected classification metrics, that the Extreme Gradient Boosting method performs the best in predicting US stock market crisis events.