Iijcs 2014 05 17 021

IPASJ International Journal of Computer Science(IIJCS)
Web Site: http://www.ipasj.org/IIJCS/IIJCS.htm

A Publisher for Research Motivation ........ Email: editoriijcs@ipasj.org
Volume 2, Issue 5, May 2014 ISSN 2321-5992

Volume 2 Issue 5 May 2014 Page 31

Abstract
In this paper, we discuss results of forecasting nonstationary financial time series such as IIP usi ng yield spread between long
and short-term rates with Wavelet Neural Networks. Using the yields on securities with maturities ranging from three months to
ten years, we analyzed four different long minus short yield spreads (policy horizon and non-policy horizon) . We observed the
predictive power of each of these spreads for economic activity within aggregate and time scale framework using Wavelet
Neural Networks gives slightly better forecasting ability than Neural Networks and significantly better results can be obtained
than other conventional techniques. We also recommend the use of lagged IIP for greater efficiency that enables the yield
spread to produce better IIP forecasts.

Keywords: Time series, IIP Growth, Yield Spread, Forecasting, Wavenets, Neural Networks.

1. INTRODUCTION
Financial time series such as stock market index, exchange rate etc are inherently non-stationary, it is regarded as one
of the most challenging applications of time series forecasting. Whilst non-linear models are often used for a variety of
purposes, one of their prime uses is for forecasting, and it is in terms of their forecasting performance that they are
most often judged. However, a casual review of the literature suggests that often the forecasting performance of such
models is not particularly good. The relatively poor forecasting performance of some non-linear models calls for
substantive further research in this area, given that one might feel uncomfortable asserting that non-linearities are
unimportant in describing economic and financial phenomena[1]. Wavelet Neural Networks for financial time series
forecasting with regard to certain parameters and expect better results than other techniques such as Fourier methods,
statistical techniques, numerical methods and neural networks etc.

2. Wavelet Neural Networks in Financial Time Series Forecasting
In recent years, wavelets have become a very active subject in many scientific and engineering research areas.
Especially, wavelet neural networks (WNN) inspired by both the feedforward neural networks and wavelet
decompositions have received considerable attention and become a popular tool for function approximation[2]. Wavelet
neural networks are feedforward neural networks with one hidden layer, comprised normally of radial (e.g. Mexican
hat) wavelets as activation functions, and a linear output layer. The output layer of the wavelet neural network
represents the weighted sum of the hidden layer units, i.e. wavelet basis functions[3]. The structure of the wavelet
network is similar to that of the radial basis function (RBF) network except that in the wavelet network the radial basis
functions are replaced by orthonormal scaling functions that are not necessarily radial-symmetric. In contrast to
classical sigmoidal-based artificial neural networks (AAN), wavelet networks provide efficient network construction
techniques, faster training times, and multiresolution analysis capabilities. At present, there are two different kinds of
wavelet neural network structure, one with fixed wavelet bases, where the dilation and translation parameters of
wavelet basis are fixed, and only the output layer weights are adjustable. Another type is the variable wavelet bases,
where the dilation parameters, translation parameters and the output layer weights are adjustable[4]. Wavenet is
another term to describe wavelet networks. Originally, wavenets did refer to neural networks using dyadic wavelets. In
wavenets, the position and dilation of the wavelets are fixed and the weights are optimised by the network so they
belong to the first category of wavelet neural networks. The theory of wavenets has been generalised to many different
settings such as biorthogonal wavenets, fuzzy wavenets, multiresolution analysis wavenets etc. We limit the scope of
Using Wavelet Neural Networks to Forecast IIP
Growth with Yield Spreads

M. Yasin Pir
1
, Firdous Ahmad Shah
2
M. Asger
3

1
Department of Computer Applications, Govt. College for Women, M.A.Road,
Srinagar-190010, J &K,India.

2
Department of Mathematics, South Campus, University of Kashmir,
Anantnag-192101, J &K, India.

3
School of Mathematical Sciences & Engineering, BGSB University,
Rajouri-185131, J &K, India.


this section to the first category of wavelet neural networks[5]. Wavelet Neural Networks can be used for financial time
series forecasting with regard to certain parameters and better results are expected than other techniques.

Frame work of the Forecasting Model

1. Decompose original time series using wavelet decomposition and obtain the corresponding approximation and
details series at a predetermined level of resolution.
2. Design neural network predictive model for each of the decomposed components of the original time series
3. Input variables of the neural network models for each of the decomposed series, comprising of technical
indicators.
4. Use the model for arriving at the results.

3. DATA AND METHODOLOGY
The data is collected fromRBI [6]. In this study, monthly data fromOctober 1996 to June 2012, which gives a data
window size of 189 observations, have been used to test the predictability of yield spreads for forecasting output growth.
Index for Industrial Production (IIP) is considered to derive the output growth For the construction of yield spreads, we
use the spread between the long termyields to maturity (YTM) on Government of India (GOI) securities and short term
Treasury bill rates constructed at shorter end, longer end and policy relevant areas of yield curve. These spreads include
one year yields minus three months Treasury bill rate (Sp 1, 3) and ten year yields minus five year yields (Sp 10, 5) which
are known as policy horizon spreads, whereas, five year yields minus three months Treasury bill rate (Sp 5, 3) and ten
year yields minus three months Treasury bill rate (Sp 10, 3) are known as Non-policy horizon spreads. The results are
graphically depicted in Fig. 1.1 to Fig.1.5.



In our study, the Original Time Series values (IIP Growth and 4 constructed spreads) are normalized. The normalization
step will rescale the orginal time series and will minimize the effect of outliers in the series and the series is reduced to
zero mean and unit standard deviation. The following transformation would transform the original input variables x
1
, x
2
,
x
3
,.. x
d
into normalized variables x
1
; x
2
,x
3
, x
d
.
i=1..d

Two approaches are followed. In the first approach (Model 1), the normalized values of IIP Growth and four constructed
spreads are fed to the neural network model separately such as : IIP Growth and Sp(1,3) , IIP Growth and Sp(10,5), IIP
Growth and Sp(5,3) and IIP Growth and Sp(10,3) respectively. The lagged IIP Growth values which lag by value of 1, 2,
3 and 4 (namely lag1, lag2, lag3 and lag4) and the values of four constructed spreads are fed to the network
independently and the observations are recorded for the forecasted values of IIP Growth by neural network model. Neural
Network GUI toolbox of Matlab (R2010a) was used for this purpose[7] . The results are graphically depicted in Fig 2.1 to
Fig 2.5.

In the second approach (Model 2), the normalized values of IIP Growth and four constructed spreads are de-noised using
wavelets before they are fed to the neural network model and same procedure is followed to forecast IIP Growth values as
was used in Model 1 after De-noising step.

Fig. Model 2


One-Dimensional Discrete Stationary Wavelet Transform (SWT) was used for De-noising. De-noising requires
thresholdingthat discards only the portion of the details that exceeds a certain limit. Using wavelets to remove noise from
a signal requires identifying which component or components contain the noise and then reconstructing the signal
without those components. The Wavelet GUI Toolbox of Matlab (R2010a) was used for this purpose that includes
automatic thresholding[8]. The results are graphically depicted in Fig 3.1 to 3.5.

The de-noising procedure proceeds in three steps:

1. Decomposition by any wavelet. In our case Daubechies wavelet at level 2 was used.
2. Thresholding detail coefficients. For level 2 in our case, fixed formthreshold was chosen and soft thresholding
was applied to detail coefficients.
3. Reconstruction. In our case the reconstructed series at level 2 are IIP Growth values and four constructed spreads.

In both the approaches, Feed forward back propagation network was created. The training function TRAINLM is used
that updates weight and bias states according to Levenberg-Marquardt optimization which is often the fastest
backpropagation algorithmin the toolbox. The adaptive learning function LEARNGDM is used which is the gradient
descent with momentumweight and bias learning function. A two layer feed forward backpropagation network was
created with 10 number of neurons in the hidden layer which gave the optimumresults in this network. The transfer
function used is tansig which is a Hyperbolic tangent sigmoid transfer function which is fastest as well. The
performance function used is MSE (Mean Squared Error). The following Regression Analysis were obtained for IIP
Growth & 4 constructed spreads with two approaches discussed above.


Performance Function-Mean Squared Error(MSE)
Model 1-(Neural Network Approach)
Lag Sp(1,3) Sp(10,5) Sp(5,3) Sp(10,3)
1 3.91E-12 1.31E-12 3.68E-12 4.22E-12
2 2.31E-12 7.89E-13 6.01E-12 4.06E-12
3 7.78E-12 2.98E-12 3.79E-12 3.91E-12
4 3.97E-12 3.12E-12 3.34E-12 3.84E-12
Model 2-(Wavelet Neural Network Approach)
1 3.52E-12 5.77E-13 3.22E-12 4.72E-12
2 2.54E-12 4.29E-13 1.25E-12 3.49E-12
3 3.78E-12 2.68E-12 3.35E-12 3.83E-12
4 3.11E-12 1.22E-12 2.03E-12 3.09E-12

4. CONCLUSION

1. The spread is a reliable predictor of output growth such as IIP and that the spread provides good recession forecasts,
especially up to one year ahead.
2. Since better regression results are obtained from both the approaches which implies that both the approaches can
successfully forecast the IIP Growth than other models.
3. In both the approaches, it is evident that ten year yields minus five year yields (Sp 10, 5) which are known as policy
horizon spreads remains an important variable in predicting IIP Growth than other spreads.
4. The use of lagged IIP enables greater efficiency for yield spreads to produce better IIP forecasts. The best results are
obtained at lag 2 in both the approaches and Sp(10,5); the forecasting results are depicted graphically in Fig 4.1 &
Fig 4.2. using Neural Network Approach and Wavelet Neural Network Approach respectively.
5. Using Wavelet Neural Network Approach gives slightly better forecasting results than Neural network Approach.

References
[1] Michael P. C, Philip H.N., and Swanson R., Forecasting economic and financial time-series with non-linear
models, International Journal of Forecasting 20 169 183 (2004).
[2] V. Kodogiannis, I. Petrounias, and J. Lygouras, "Adaptive Wavelet Neural Networks for Non-linear Modelling and
Control," NEURAL PARALLEL AND SCIENTIFIC COMPUTATIONS, vol. 15, p. 221, 2007.
[3] E A Rying, G L Bilbro and Jye-Chyi Lu, Focused local learning with wavelet neural networks, IEEE
Transactions on Neural Networks ,02/2002; vol. 13(2):304-19,2002.
[4] Daniel W.C.Ho, Ping-An Zhang , and J inhua Xu, Fuzzy Wavelet Networks form Function Learning , IEEE
Transactions on Fuzzy Systems, Vol 9, No. 1,February 2001.
[5] Marc Thuillard , A Review of Wavelet Networks, Wavenets, Fuzzy Wavenets and Applications, Advances in
Computational Intelligence and Learning , International Series in Intelligent Technologies Volume 18, pp 43-60 ,
2002.
[6] IIP Growth. Available at http:// www.rbi.org.in.
[7] Neural Network Toolbox Users Guide, The MathWorks, Inc. available at http://www.mathworks.com.
[8] MATLAB- The Language of Technical Computing, available at : http://www.mathworks.com/products/matlab.


AUTHOR

M. Yasin Pir received M.C.A. (Master of Computer Application) from Kashmir University,India in 2004.
During 2005-2011, he was working as Assistant Professor in the Department of Computer Sciences in
BGSB University, J&K and is pursuing his research from the same University. He is presently working as
Assistant Professor in Higher Education Department, J&K,India.

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