Extracting Discriminative Features Using Non-negative Matrix Factorization in Financial Distress Data

Abstract

In the recent financial crisis the incidence of important cases of bankruptcy led to a growing interest in corporate bankruptcy prediction models. In addition to building appropriate financial distress prediction models, it is also of extreme importance to devise dimensionality reduction methods able to extract the most discriminative features. Here we show that Non-Negative Matrix Factorization (NMF) is a powerful technique for successful extraction of features in this financial setting. NMF is a technique that decomposes financial multivariate data into a few basis functions and encodings using non-negative constraints. We propose an approach that first performs proper initialization of NMF taking into account original data using K-means clustering. Second, builds a bankruptcy prediction model using the discriminative financial ratios extracted by NMF decomposition. Model predictive accuracies evaluated in real database of French companies with statuses belonging to two classes (healthy and distressed) are illustrated showing the effectiveness of our approach.