Novel feature selection methods to financial distress prediction

• An integrated feature selection method is proposed to predict distress firms.
• This method (HARC) embeds the experts’ knowledge with the wrapper method.
• The financial ratios are categorized into seven classes using experts’ knowledge.
• The prediction model based on HARC performs better than existing methods.

Financially distressed prediction (FDP) has been a widely and continually studied topic in the field of corporate finance. One of the core problems to FDP is to design effective feature selection algorithms. In contrast to existing approaches, we propose an integrated approach to feature selection for the FDP problem that embeds expert knowledge with the wrapper method. The financial features are categorized into seven classes according to their financial semantics based on experts’ domain knowledge surveyed from literature. We then apply the wrapper method to search for “good” feature subsets consisting of top candidates from each feature class. For concept verification, we compare several scholars’ models as well as leading feature selection methods with the proposed method. Our empirical experiment indicates that the prediction model based on the feature set selected by the proposed method outperforms those models based on traditional feature selection methods in terms of prediction accuracy.