The Shortcomings of Discriminant Analysis

Shortcomings of Discriminant Analysis:

Of the applied discriminant analysis applications that have appeared in business,finance,and economics ,most have suffered from methodological or statistical problems limiting their usefulness.These problems not limited to the areas of finance or economics only.The problems are of several types,among which difficulties include

(a)distribution of variables

(b)group dispersion

(c) interpretation of significance of individual variables

(d)reduction of dimensionality

(e)definition of groups

(f)costs of mis-classification

(g)estimation of error

One important pitfall is that standard discriminant analysis procedures assume variables to describe or characterize variables as normally distributed.However in practice deviations from normality assumptions in economics and finance is more a rule than assumption.Violation of the assumption may bias the tests of significance and standard error.Hence it is of interest to determine whether the assumption holds and what effects its relaxation may have on the tests and classification.

There are many such questions about discriminant analysis yet to be answered!!

Group: Finance 2
Author: Vrishti Garg