This post is inspired by Leo Breiman’s opinion piece “No Bayesians in foxholes”. The saying “there are no atheists in foxholes” refers to the fact that if you are in the foxhole (being bombarded..), you pray! Leo’s paraphrase indicates that when complex, real problems are present, there are no Bayesian to be found.

# Category: Statistics and Econometrics

## Random forest importance measures are NOT important

Random Forests (RF from here onwards) is a widely used pure-prediction algorithm. This post assumes good familiarity with RF. If you are not familiar with this algorithm, stop here and see the first reference below for an easy tutorial. If you used RF before and you are familiar with it, then you probably encountered those “importance of the variables” plots. We start with a brief explanation of those plots, and the concept of *importance scores* calculation. Main takeaway from the post: don’t use those *importance scores* plots, because they are simply misleading. Those importance plots are simply a wrong turn taken by our human tendency to look for reason, whether it’s there or it’s not there.

## Beta in the tails

Every form of strength is also a form of weakness^{*}. I love statistics, but I focus to much on methodology, which is not for everyone. Some people (right or wrong) question: “wonderful sir, but what can I do with it?”.

A new paper titled *“Beta in the tails”* is a showcase application for why we should focus on correlation structure rather than on average correlation. They discuss the question: *Do hedge funds hedge?* The reply: No, they don’t!

The paper *“Beta in the tails”* was published in the *Journal of Econometrics* but you can find a link to a working paper version below. We start with a figure replicated from the paper, go through the meaning and interpretation of it, and explain the methods used thereafter.

## How flexible neural networks really are?

Very!

A distinctive power of neural networks (neural nets from here on) is their ability to flex themselves in order to capture complex underlying data structure. This post shows that the expressive power of neural networks can be quite swiftly taken to the extreme, in a bad way.

What does it mean? A paper from 1989 (universal approximation theorem, reference below) shows that any reasonable function can be approximated arbitrarily well by fairly a shallow neural net.

Speaking freely, if one wants to abuse the data, to overfit it like there is no tomorrow, then neural nets is the way to go; with neural nets you can perfectly map your fitted values to any data shape. Let’s code an example and explain the meaning of this.

## Correlation and correlation structure (5) – a new coefficient of correlation

This is the fifth post which is concerned with quantifying the dependence between variables. When talking correlations one usually thinks about linear correlation, aka Pearson’s correlation. One serious limitation of linear correlation is that it’s, well.. linear. By construction it’s not useful for detecting non-monotonic relation between variables. Here I share some recent academic research, a new way to detect associations that are **not** monotonic.

## Understanding Variance Explained in PCA – Matrix Approximation

Principal component analysis (PCA from here on) is performed via linear algebra functions called eigen decomposition or singular value decomposition. Since you are actually reading this, you may well have used PCA in the past, at school or where you work. There is a strong link between PCA and the usual least squares regression (previous posts here and here). More recently I explained what does variance explained by the first principal component actually means.

This post offers a matrix approximation perspective. As a by-product, we also show how to compare two matrices, to see how different they are from each other. Matrix approximation is a bit math-hairy, but we keep it simple here I promise. For this fascinating field itself I suspect a rise in importance. We are constantly stretching what we can do computationally, and by using approximations rather than the actual data, we can ease that burden. The price for using approximation is decrease in accuracy (à la “garbage in garbage out”), but with good approximation the tradeoff between the accuracy and computational time is favorable.

## Why complex models are data-hungry?

If you regularly read this blog then you know I am not one to jump on the “AI Bandwagon”, being quickly weary of anyone flashing the “It’s Artificial Intelligence” joker card. Don’t get me wrong, I understand it is a sexy term I, but to me it always feels a bit like a sales pitch.

If the machine does anything (artificially) intelligent it means that the model at the back is complex, and complex models need massive (**massive** I say) amounts of data. This is because of the infamous Curse of dimensionality.

I know it. You know it. Complex models need a lot of data. You have read this fact, even wrote it at some point. But why is it the case? “So we get a good estimate of the parameter, and a good forecast thereafter”, you reply. I accept. But.. what is it about simple models that they could suffice themselves with much less data compared to complex models? Why do I always recommend to start simple? and why the literature around shrinkage and overfitting is as prolific as it is?

## Correlation and correlation structure (4) – asymmetric correlations of equity portfolios

Here I share a refreshing idea from the paper “Asymmetric correlations of equity portfolios” which was published in the *Journal of financial Economics*, a top tier journal in this field. The question is how much the observed conditional correlation on the downside (say) differs from the conditional correlation you would expect from a symmetrical distribution. You can find here an explanation for the H-statistic developed in the aforementioned paper and some code for illustration.

## Understanding Spectral Clustering

Some problems are linear, but some problems are non-linear. I presume that you started your education discussing and solving linear problems which is a natural starting point. For non-linear problems solutions often involve an initial processing step. The aim of that initial step is to transform the problem such that it has, again, linear flavor.

A textbook example is the logistic regression, a tried-and-true recipe for getting the best linear boundary between two classes. In a standard neural network model, you will find logistic regression (or multinomial regression for multi-class output) applied on transformed data. Few preceding layers are “devoted” to transform a non-separable input-space into something which linear methods could handle, allowing the logistic regression to solve the problem with relative ease.

The same rationale holds for spectral clustering. Rather than working with the original inputs, work first with a transformed data which would make it easier to solve, and then link back to your original inputs.

Spectral clustering is an important and up-and-coming variant of some fairly standard clustering algorithms. It is a powerful tool to have in your modern statistics tool cabinet. Spectral clustering includes a processing step to help solve non-linear problems, such that they could be solved with those linear algorithms we are so fond of. For example, the undeniably popular K-means.

## Boundary corrected kernel density

Density estimation is now a trivial one-liner script in all modern software. What is not so easy is to become comfortable with the result, how well is is my density estimated? we rarely know. One reason is the lack of ground-truth. Density estimation falls under unsupervised learning, we don’t actually observe the actual underlying truth. Another reason is that the theory around density estimation is seldom useful for the particular case you have at hand, which means that trial-and-error is a requisite.

Standard kernel density estimation is by far the most popular way for density estimation. However, it is biased around the edges of the support. In this post I show what does this bias imply, and while not the only way, a simple way to correct for this bias. Practically, you could present density curves which makes sense, rather than apologizing (as I often did) for your estimate making less sense around the edges of the chart; that is, when you use a standard software implementation.

## Machine learning is simply statistics – part 2

Another opinion piece.

If you can’t explain it simply you don’t understand it well enough.

(Albert Einstein)

## Curse of Dimensionality part 4: Distance Metrics

Many machine learning algorithms rely on distances between data points as their input, sometimes the only input, especially so for clustering and ranking algorithms. The celebrated k-nearest neighbors (KNN) algorithm is our example chief, but distances are also frequently used as an input in the natural language processing domain; “You shall know a word by the company it keeps” (Firth, J. R. 1957:11); e.g. the word “jaguar” refers to the animal if words like “zoo” or “safari” are also in the neighborhood. But would refer to a mark of a car if words such as “parking” or “highway” are nearby. But (and a big one), ‘in the neighborhood’ means one thing in a low-dimension settings, and another thing in high-dimensional settings. This post emphasizes this important difference- another example of the curse of dimensionality; measuring distance in high dimension.

## Understanding Pointwise Mutual Information in Statistics

### Intro

The term mutual information is drawn from the field of information theory. Information theory is busy with the quantification of information. For example, a central concept in this field is entropy, which we have discussed before.

If you google the term “mutual information” you will land at some page which if you understand it, there would probably be no need for you to google it in the first place. For example:

Not limited to real-valued random variables and linear dependence like the correlation coefficient, mutual information (MI) is more general and determines how different the joint distribution of the pair (X,Y) is to the product of the marginal distributions of X and Y. MI is the expected value of the pointwise mutual information (PMI).

which makes sense at first read only for those who don’t need to read it. It’s the main motivation for this post: to provide a clear intuition behind the *pointwise mutual information* term and equations, for everyone. At the end of this page, you would understand what *mutual information* metric actually measures, and how you should interpret it. We start with the easier concept of conditional probability and work our way through to the concept of pointwise mutual information.

## CUR matrix decomposition for improved data analysis

I have recently been reading about more modern ways to decompose a matrix. Singular value decomposition is a popular way, but there are more. I went down the rabbit whole. After a couple of “see references therein” I found something which looks to justify spending time on this. An excellent paper titled “CUR matrix decomposition for improved data analysis”. This post describes how to single-out the most important variables from the data in an unsupervised manner. Unsupervised here means without a target variable in mind.

## Understanding Variance Explained in PCA

Principal component analysis (PCA) is one of the earliest multivariate techniques. Yet not only it survived but it is arguably the most common way of reducing the dimension of multivariate data, with countless applications in almost all sciences.

Mathematically, PCA is performed via linear algebra functions called eigen decomposition or singular value decomposition. By now almost nobody cares how it is computed. Implementing PCA is as easy as pie nowadays- like many other numerical procedures really, from a drag-and-drop interfaces to `prcomp`

in R or `from sklearn.decomposition import PCA`

in Python. So implementing PCA is not the trouble, but some vigilance is nonetheless required to understand the output.

This post is about understanding the concept of *variance explained*. With the risk of sounding condescending, I suspect many new-generation statisticians/data-scientists simply echo what is often cited online: “the first principal component explains the bulk of the movement in the overall data” without any deep understanding. What does “explains the bulk of the movement in the overall data” mean exactly, actually?