Predicting Future Earnings Changes Using Machine Learning and Detailed Financial Data

Journal of Accounting Research, Forthcoming

91 Pages Posted: 3 Feb 2021 Last revised: 14 Feb 2022

See all articles by Xi Chen

Xi Chen

New York University (NYU) - Leonard N. Stern School of Business

Tony (Yang Ha) Cho

New York University (NYU) - Department of Accounting

Yiwei Dou

New York University (NYU) - Department of Accounting

Baruch Lev

New York University - Stern School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 12, 2022

Abstract

We use machine learning methods and high-dimensional detailed financial data to predict the direction of one-year-ahead earnings changes. Our models show significant out-of-sample predictive power: the area under the Receiver Operating Characteristics curve (AUC) ranges from 67.52 to 68.66 percent, significantly higher than the 50 percent of a random guess. The annual size-adjusted returns to hedge portfolios formed based on the prediction of our models range from 5.02 to 9.74 percent. Our models outperform two conventional models that use logistic regressions and small sets of accounting variables, and professional analysts’ forecasts. Analyses suggest that the outperformance relative to the conventional models stems from both nonlinear predictor interactions missed by regressions and the use of more detailed financial data by machine learning.

Keywords: Direction of Earnings Changes; Prediction; Detailed Financial Data; XBRL; Machine Learning

JEL Classification: C53; G12; G17; M41

Suggested Citation

Chen, Xi and Cho, Yang Ha and Dou, Yiwei and Lev, Baruch Itamar, Predicting Future Earnings Changes Using Machine Learning and Detailed Financial Data (February 12, 2022). Journal of Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3741015 or http://dx.doi.org/10.2139/ssrn.3741015

Xi Chen

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

Yang Ha Cho

New York University (NYU) - Department of Accounting ( email )

40 West 4th Street
Suite 10-180
New York, NY 10012
United States

Yiwei Dou (Contact Author)

New York University (NYU) - Department of Accounting ( email )

40 West 4th Street
Suite 10-180
New York, NY 10012
United States

Baruch Itamar Lev

New York University - Stern School of Business ( email )

40 West 4th Street, Suite 400
New York, NY 10012
United States
212-998-0028 (Phone)
212-995-4001 (Fax)

HOME PAGE: http://www.baruch-lev.com

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