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Choice of K in K-fold Cross Validation for Classification in Financial Market

Cross Validation is often used as a tool for model selection across classifiers. As discussed in detail in the following paper https://ssrn.com/abstract=2967184, Cross Validation is typically performed in the following steps:

  • Step 1: Divide the original sample into K sub samples; each subsample typically has equal sample size and is referred to as one fold, altogether, K-fold.
  • Step 2: In turn, while keeping one fold as a holdout sample for the purpose of Validation, perform Training on the remaining K-1 folds; one needs to repeat this step for K iterations.
  • Step 3: The performance statistics (e.g., Misclassification Error) calculated from K iterations reflects the overall K-fold Cross Validation performance for a given classifier.

However, one question often pops up: how to choose K in K-fold cross validation. The rule-of-thumb choice often suggested by literature based on non-financial market is K=10. The question is: is it true for Financial Market?

In the following paper, in the context of Financial Market, we compare a range of choices for K in K-fold cross validation for the following 8 most popular classifiers:

  • Neural Network
  • Support Vector Machine
  • Ensemble
  • Discriminant Analysis.
  • Naïve Bayes.
  • K-nearest Neighbours.
  • Decision Tree.
  • Logistic Regression

For those who want to know a bit more, the paper is available: https://ssrn.com/abstract=2967184