Overfitting

AAA

DEFINITION of 'Overfitting'

A modeling error which occurs when a function is too closely fit to a limited set of data points. Overfitting the model generally takes the form of making an overly complex model to explain idiosyncrasies in the data under study. In reality, the data being studied often has some degree of error or random noise within it. Thus attempting to make the model conform too closely to slightly inaccurate data can infect the model with substantial errors and reduce its predictive power.

INVESTOPEDIA EXPLAINS 'Overfitting'

Financial professionals must always be aware of the dangers of overfitting a model based on limited data. For instance, a common problem is using computer algorithms to search extensive databases of historical market data in order to find patterns. Given enough study, it is often possible to develop elaborate theorems which appear to predict things such as returns in the stock market with close accuracy. However, when applied to data outside of the sample, such theorems may likely prove to be merely an overfitting of a model to what were in reality just chance occurrences. In all cases, it is important to test a model against data which is outside of the sample used to develop it.

RELATED TERMS
  1. Non-Sampling Error

    A statistical error caused by human error to which a specific ...
  2. Stochastic Modeling

    A method of financial modeling in which one or more variables ...
  3. Multiple Linear Regression - MLR

    A statistical technique that uses several explanatory variables ...
  4. Regression

    A statistical measure that attempts to determine the strength ...
  5. Financial Modeling

    The process by which a firm constructs a financial representation ...
  6. International Finance Corporation

    The International Finance Corporation is an organization dedicated ...
Related Articles
  1. Build A Model Portfolio With Style Investing
    Mutual Funds & ETFs

    Build A Model Portfolio With Style Investing

  2. Do-It-Yourself Analyst Predictions
    Fundamental Analysis

    Do-It-Yourself Analyst Predictions

  3. Multivariate Models: The Monte Carlo ...
    Options & Futures

    Multivariate Models: The Monte Carlo ...

  4. Style Matters In Financial Modeling
    Professionals

    Style Matters In Financial Modeling

comments powered by Disqus
Hot Definitions
  1. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory ...
  2. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  3. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  4. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  5. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
  6. Over The Counter

    A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" ...
Trading Center