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What is predictive modeling? It’s a mathematical process focused on analyzing patterns in historical data to predict what will happen in the future. It can be applied to many fields of business, including finance since it has a plethora of applications. What are they? Find it out in this article!
Table of Contents
What Is Predictive Modeling?
Predictive modeling is a part of data analytics which incorporates machine learning to predict future events based on past data. In practice, it’s a complex mathematical model that analyses historical data to find patterns (often ones that we wouldn’t spot as humans) and then looks for the same patterns in current data.
How Does Predictive Modeling Work?
Not every predictive modeling engine is the same – there are multiple techniques for working on data. We can distinguish between:
- regression models – these predict continuous numerical values based on input variables; their purpose is to understand the relationship between the variables; used mostly in financial analysis and economics,
- neural networks – AI-powered models that learn complex relationships between the variables; used mainly in natural language processing (NLP),
- classification models – used to segregate data into several categories; may be used in, for instance, marketing to sieve out spam e-mails,
- clustering models – used to group data based on similarities; usually used for customer segmentation,
- time series – used to identify patterns in data over time and to predict values based on it; used for financial analytics, economics, predicting stock prices and… weather forecasting.
Predictive Modelling in Financial Services and Analytics
Predictive modeling is a way to utilize AI and machine learning for financial forecasting, but they also have some additional applications. How can you utilize it in your business? Take a look at the examples below.
Credit Scoring and Loan Approval
You may use predictive modeling techniques to enhance your credit scoring process. An AI-powered engine can analyze the financial history of your client for your employees and detect patterns that might indicate whether they are fit (or unfit) for the loan. This enables you to minimize the risk by basing your decisions on complete data.
Fraud Detection
Predictive modeling can also be used as a basis for your AI-powered transaction monitoring software. Similarly to the case with credit scoring, artificial intelligence can analyze historical data (both general and specific about a given client) and alert you if it sees patterns indicating fraud attempts. This way, you can be more accurate in reporting potentially fraudulent transactions and ensure compliance with the AML regulations.
Algorithmic Trading
Algorithmic trading is nothing new, but when enhanced with AI, it can reach a completely new level. Thanks to natural language processing, an AI-powered system can analyze unstructured information (e.g., news feeds) to look for more indicators of certain changes in the market. As a result, it will provide you with more accurate predictions regarding price fluctuations.
Churn Prediction and Customer Retention Strategies
Another way you can utilize predictive modeling is to keep your customers on board. For starters, thanks to such systems, you will be able to define which clients are about to churn – often, before they even know about it. At the same time, with predictive modeling, you can extract insights about past customer retention strategies that worked out and act proactively to predict churn.
Customer Lifetime Value (CLV) Prediction
Finally, you may use predictive modeling to estimate customer lifetime value for each of your clients. This enables you to personalize your offer and make the most of each customer.
The Takeaway
Predictive modeling is a powerful tool in finance, enabling you to optimize your services and make better, data-driven decisions. What we did not mention in this article is all the applications in fields like marketing and sales, which raise the stakes even higher. Therefore, implement predictive modeling at your company and embrace the power of data!
Need help designing and developing your model? Find out more about our financial technology services!
