Patent ID: 7328182

Claim:
A computer-based method for prediction of behavior in a financial system using financial return data, the method comprising the steps of: inputting the financial return data and a set of independent variables corresponding to properties of the financial system into a computer, wherein the financial return data comprises a plurality of data points having multiple co-variances which are collected over time; generating a co-variance matrix comprising the steps of: (a) defining a first loading matrix having elements comprising a first subset of independent variables within the set of independent variables, the first subset comprising a least quantity of independent variables estimated to fit the financial return data; (b) determining a goodness-of-fit to the financial return data according to a selected goodness-of-fit criterion for each independent variable within the first loading matrix; (c) culling each independent variable within the first loading matrix whose presence or elimination fails to change the goodness-of-fit to produce a reduced element first loading matrix; (d) defining a next loading matrix containing a larger subset of independent variables than the first loading matrix; (e) adding the next loading matrix to the reduced element first loading matrix to define a combination of loading matrix elements; (f) determining the goodness-of-fit to the financial return data for the combination of loading matrix elements; (g) culling each independent variable of the combination of loading matrix elements whose presence or elimination fails to change the goodness-of-fit; and (h) repeating steps (d) through (g) until the goodness-of-fit to the financial return data meets the selected goodness-of-fit criterion in a final iteration, wherein the resulting co-variance matrix comprises the combination of loading matrix elements wherein the number of off-diagonal, non-zero loading matrix elements in the co-variance matrix is minimized and wherein the remaining independent variables comprise the smallest subset of independent variables that fits the financial return data.