Reinforcement learning
In reinforcement learning, we train agents who take actions in an environment, such as a self-driving car on the road. While we do not have labels, that is, we cannot tell what the correct action is in any situation, we can assign rewards or punishments. For example, we could reward keeping a proper distance from the car in front.
Reinforcement learning
A driving instructor does not tell the student to "push the brake halfway down while moving the steering wheel two degrees to the right," but rather they tell the student whether they are doing well or not, while the student figures out the exact amount of brakes to use.
Reinforcement learning has also made some remarkable progress in the past couple of years and is considered by many to be a promising avenue toward general artificial intelligence, that being computers that are as smart as humans.
The unreasonable effectiveness of data
In 2009, three Google engineers published a landmark paper titled The unreasonable effectiveness of data. In the paper, they described how relatively simple machine learning systems that had been around for a long time had exhibited much better performance when fed with the enormous amounts of data Google had on its servers. In fact, they discovered that when fed with more data, these simple systems could master tasks that had been thought to be impossible before.
From there, researchers quickly started revisiting old machine learning technologies and found that artificial neural networks did especially well when trained on massive datasets. This was around the same time that computing power became cheap and plentiful enough to train much bigger networks than before.
These bigger artificial neural networks were so effective that they got a name: deep neural networks, or deep learning. Deep neural networks are especially good at pattern detection. They can find complex patterns, such as the statistical pattern of light and dark that describes a face in a picture, and they can do so automatically given enough data.
Machine learning is, therefore, best understood as a paradigm change in how we program computers. Instead of carefully handcrafting rules, we feed the computer vast amounts of information and train it to craft the rules by itself.
This approach is superior if there is a very large number of rules, or even if these rules are difficult to describe. Modern machine learning is, therefore, the ideal tool for combing through the huge amounts of data the financial industry is confronted with.
All models are wrong
There is a saying in statistics that all models are wrong, but some are useful. Machine learning creates incredibly complex statistical models that are often, for example, in deep learning, not interpretable to humans. They sure are useful and have great value, but they are still wrong. This is because they are complex black boxes, and people tend to not question machine learning models, even though they should question them precisely because they are black boxes.
There will come a time when even the most sophisticated deep neural network will make a fundamentally wrong prediction, just as the advanced Collateralized Debt Obligation (CDO) models did in the financial crises of 2008. Even worse, black box machine learning models, which will make millions of decisions on loan approval or insurance, impacting everyday people's lives, will eventually make wrong decisions.
Sometimes they will be biased. Machine learning is ever only as good as the data that we feed it, data that can often be biased in what it's showing, something we'll consider later on in this chapter. This is something we must pay a lot of time in addressing, as if we mindlessly deploy these algorithms, we will automate discrimination too, which has the possibility of causing another financial crisis.
This is especially true in the financial industry, where algorithms can often have a severe impact on people's lives while at the same time being kept secret. The unquestionable, secret black boxes that gain their acceptance through the heavy use of math pose a much bigger threat to society than the self-aware artificial intelligence taking over the world that you see in movies.
While this is not an ethics book, it makes sense for any practitioner of the field to get familiar with the ethical implications of his or her work. In addition to recommending that you read Cathy O'Neil's Weapons of math destruction, it's also worth asking you to swear The Modelers Hippocratic Oath. The oath was developed by Emanuel Derman and Paul Wilmott, two quantitative finance researchers, in 2008 in the wake of the financial crisis:
"I will remember that I didn't make the world, and it doesn't satisfy my equations. Though I will use models boldly to estimate value, I will not be overly impressed by mathematics. I will never sacrifice reality for elegance without explaining why I have done so. Nor will I give the people who use my model false comfort about its accuracy. Instead, I will make explicit its assumptions and oversights. I understand that my work may have enormous effects on society and the economy, many of them beyond my comprehension."
In recent years, machine learning has made a number of great strides, with researchers mastering tasks that were previously seen as unsolvable. From identifying objects in images to transcribing voice and playing complex board games like Go, modern machine learning has matched, and continues to match and even beat, human performance at a dazzling range of tasks.
Interestingly, deep learning is the method behind all these advances. In fact, the bulk of advances come from a subfield of deep learning called deep neural networks. While many practitioners are familiar with standard econometric models, such as regression, few are familiar with this new breed of modeling.
The bulk of this book is devoted to deep learning. This is because it is one of the most promising techniques for machine learning and will give anyone mastering it the ability to tackle tasks considered impossible before.
In this chapter, we will explore how and why neural networks work in order to give you a fundamental understanding of the topic.