Summary of the Updated Code

This code provides a comprehensive end-to-end implementation for fraud detection with the
following key steps:

1. Data Preprocessing

1. Missing Value Detection:

o Checks for missing values in the dataset.

2. Outlier Handling:

o Uses Z-scores and boxplots to detect and visualize outliers.

o Capping outliers to the 1st and 99th percentiles to mitigate their impact.

2. Feature Engineering

1. Restores isFraud:

o Adds back the isFraud column for correlation analysis and modeling.

2. Constant Column Removal:

o Identifies and drops features with no variance.

3. Derived Features:

o Creates features like orig_balance_diff, dest_balance_diff, orig_balance_ratio,

and dest_balance_ratio based on balance columns.

4. Multicollinearity Detection:

o Uses Variance Inflation Factor (VIF) to detect and remove highly collinear
features.

5. Correlation Analysis:

o Analyzes derived features' correlation with isFraud and drops low-correlation

features.

6. Log Transform:

o Reduces skewness in amount and orig_balance_ratio with log transformation.

3. Class Imbalance Handling

• Balances the dataset using SMOTE (Synthetic Minority Oversampling Technique) to

generate synthetic samples for the minority class.
4. Model Training and Evaluation

1. Random Forest Classifier:

o Trains the model on resampled data with verbose output for tracking.

o Uses chunked predictions during testing for progress updates.

2. Model Evaluation:

o Outputs the classification report, ROC-AUC score, and confusion matrix.

3. Feature Importance:

o Visualizes the importance of each feature in predicting fraud.

Key Outputs

1. Classification Report:

o Provides precision, recall, and F1-score for each class.

2. Confusion Matrix:

o Visualizes true positives, true negatives, false positives, and false negatives.

3. Feature Importance:

o Highlights the contribution of each feature in the model.

Advantages of the Code

1. Scalable:

o Handles large datasets efficiently with chunked processing.

2. Informative:

o Provides detailed insights through feature engineering, evaluation metrics, and

visualizations.

3. Balanced Approach:

o Uses SMOTE to address class imbalance, ensuring better model performance on

the minority class.
Summary of the Process and Outputs

Key Steps and Results

1. Missing Values Handling:

o No missing values were found in the dataset (isnull().sum() showed all columns
have complete data).

2. Outliers Detection and Handling:

o Outliers were detected across multiple numerical features using Z-scores.

o They were capped to the 1st and 99th percentiles to reduce their impact.

3. Feature Engineering:

o Derived features were successfully created (orig_balance_diff, dest_balance_diff,

orig_balance_ratio, dest_balance_ratio).

o Features with high multicollinearity (VIF > 5) were removed: oldbalanceOrg,

newbalanceOrig, oldbalanceDest, newbalanceDest.

o Low-correlation features with isFraud were dropped: dest_balance_diff,

dest_balance_ratio.

4. Class Imbalance Handling:

o SMOTE was applied to balance the dataset, resulting in equal numbers of fraud
(1) and non-fraud (0) cases.

5. Model Training and Evaluation:

o Random Forest Classifier was trained with a balanced dataset.

o Predictions were made in chunks to track progress on the large dataset.

o The final model achieved:

▪ Precision (Class 1): 72%

▪ Recall (Class 1): 95%

▪ Weighted Avg Accuracy: ~100%

▪ ROC-AUC Score: 0.996 (excellent discriminatory power).

6. Confusion Matrix:

o True Negatives: 1,905,425

o False Positives: 897

o False Negatives: 124

o True Positives: 2,340

 o High recall indicates the model successfully identifies fraud cases while
maintaining minimal false negatives.

7. Feature Importance:

o log_orig_balance_ratio: Most significant feature in detecting fraud.

o orig_balance_diff: Second most important feature.

o log_amount: Contributes moderately.

o step: Least important feature.

1. Data Cleaning: Missing Values, Outliers, and Multi-Collinearity

a. Missing Values

• Process:

o Used isnull().sum() to detect missing values for all columns.

o Found no missing values in the dataset, so no imputation or handling was

required.

• Conclusion:

o Dataset is complete with no missing values, ensuring integrity for downstream

processing.

b. Outliers

• Detection:

o Identified outliers in numerical features using Z-scores (zscore() from scipy.stats).

o Visualized outliers with boxplots for each numerical column to better understand
their distribution.

• Handling:

o Applied a percentile capping method:

▪ Capped the values at the 1st percentile (lower bound) and 99th
percentile (upper bound) to reduce the impact of extreme outliers.

o This ensured the dataset was robust without significantly altering the underlying
data distribution.

• Outcome:

o The number of outliers detected and capped:

step 66,620

amount 44,945
oldbalanceOrg 155,140

newbalanceOrig 155,931

oldbalanceDest 79,846

newbalanceDest 75,166

isFraud 8,213

isFlaggedFraud 16
c. Multi-Collinearity

• Detection:

o Used Variance Inflation Factor (VIF) to detect multicollinearity among numerical

features.

o Computed VIF values for all numeric features, identifying features with VIF > 5 as
having high multicollinearity.

• Handling:

o Dropped highly collinear features:

▪ oldbalanceOrg (VIF: 431.53)

▪ newbalanceOrig (VIF: 431.45)

▪ oldbalanceDest (VIF: 24.60)

▪ newbalanceDest (VIF: 41.07)

• Outcome:

o Multi-collinearity was successfully mitigated by removing the above features,

leaving the remaining features independent and suitable for modeling.

Summary

1. Missing Values: None found; dataset is complete.

2. Outliers: Detected and capped to the 1st and 99th percentiles.

3. Multi-Collinearity: Addressed by dropping features with high VIF values.

These steps ensured a clean and well-prepared dataset for feature engineering and modeling.
2. Fraud Detection Model

a. Model Overview

• Algorithm Used: Random Forest Classifier.

• Reason for Selection:

o Random Forest is an ensemble learning method that combines multiple decision

trees to improve predictive performance.

o It handles class imbalance and high-dimensional data well.

o Provides feature importance, aiding in interpretability.

b. Features Used
• Cleaned and Engineered Features:

o step: Time-related feature indicating the transaction timestamp.

o orig_balance_diff: Difference between oldbalanceOrg and newbalanceOrig

(original balance difference after the transaction).

o log_amount: Log-transformed transaction amount to reduce skewness.

o log_orig_balance_ratio: Log-transformed ratio of oldbalanceOrg to

newbalanceOrig (original balance ratio).

• Feature Importance:

o log_orig_balance_ratio: Most important feature.

o orig_balance_diff: Second most important.

o log_amount: Moderately important.

o step: Least important.

c. Model Training

1. Handling Class Imbalance:

o Applied SMOTE (Synthetic Minority Oversampling Technique) to balance the

dataset:

▪ Fraud cases (isFraud=1) were underrepresented in the dataset.

▪ SMOTE generated synthetic samples for the minority class, resulting in an

equal number of fraud and non-fraud cases in the training set.

2. Training Process:

o Split the dataset into 70% training and 30% testing.

 o Trained the Random Forest model with default parameters:

▪ n_estimators: 100 (number of decision trees).

▪ max_depth: None (trees are grown until pure or reach a minimum split
size).

▪ random_state: 42 (for reproducibility).

▪ verbose: Enabled for progress tracking during training.

d. Model Evaluation

1. Metrics:

o Precision (Class 1): 72% (Percentage of correctly identified fraud cases out of all
predicted fraud cases).

o Recall (Class 1): 95% (Percentage of actual fraud cases correctly identified).

o Weighted Accuracy: 100% (dominated by non-fraud cases due to class imbalance

in testing data).

o ROC-AUC Score: 0.996 (excellent discriminatory power).

2. Confusion Matrix:

o True Negatives (TN): 1,905,425 (correctly identified non-fraud cases).

o False Positives (FP): 897 (non-fraud cases incorrectly classified as fraud).

o False Negatives (FN): 124 (fraud cases missed by the model).

o True Positives (TP): 2,340 (correctly identified fraud cases).

e. Key Strengths of the Model

1. High Recall for Fraud Detection:

o The model achieves 95% recall, ensuring most fraud cases are identified.

o Low false negatives are critical in fraud detection to minimize missed fraudulent
transactions.

2. Robust to Class Imbalance:

o SMOTE ensures the model performs well on the minority fraud class despite the
initial imbalance.

3. Explainability:

o Random Forest provides feature importance, aiding in understanding the key

drivers of fraud.
f. Limitations

1. Precision for Fraud Cases:

o Precision (72%) for fraud detection could be improved. This indicates some non-
fraud cases are misclassified as fraud, which could lead to customer
dissatisfaction.

2. Processing Time:

o Training and prediction on a large dataset can be time-consuming, though

chunked predictions help mitigate this.

Summary

The Random Forest model is effective for fraud detection, achieving a high recall and ROC-AUC
score. Its feature importance helps identify the primary factors driving fraud, making it a
practical choice for deployment in real-world systems. However, further optimizations, such as
hyperparameter tuning or using alternative algorithms like XGBoost, can enhance precision and
efficiency.
3. Variable Selection for the Model

The selection of variables for the fraud detection model was a systematic process that involved
exploratory data analysis, feature engineering, and statistical techniques to ensure that only
relevant and non-redundant features were included. Below are the steps taken:

a. Initial Feature Selection

1. Included Numerical Features:

o Selected all numerical features from the dataset for initial analysis (step, amount,
oldbalanceOrg, newbalanceOrig, oldbalanceDest, newbalanceDest, isFraud, and
isFlaggedFraud).
2. Removed Constant Columns:

o Features with no variance (constant values) were identified and removed.

o Example: isFlaggedFraud was dropped as it had constant values and did not
contribute to the model.

b. Feature Engineering

1. Derived Features:

o New variables were engineered based on domain knowledge of transactions:

▪ orig_balance_diff: Difference between oldbalanceOrg and

newbalanceOrig (captures the net change in balance for the origin
account).
▪ dest_balance_diff: Difference between oldbalanceDest and
newbalanceDest (captures the net change in balance for the destination
account).

▪ orig_balance_ratio: Ratio of oldbalanceOrg to newbalanceOrig (captures

proportional changes in the origin account).

▪ dest_balance_ratio: Ratio of oldbalanceDest to newbalanceDest

(captures proportional changes in the destination account).

2. Skewness Reduction:

o Skewed features like amount and orig_balance_ratio were log-transformed to

normalize their distributions:

▪ log_amount

▪ log_orig_balance_ratio
c. Multi-Collinearity Analysis

1. Variance Inflation Factor (VIF):

o Computed VIF for all numerical features to detect multicollinearity.

o Features with VIF > 5 were dropped, as they introduced redundancy and could
negatively impact the model:

▪ oldbalanceOrg (VIF: 431.53)

▪ newbalanceOrig (VIF: 431.45)

▪ oldbalanceDest (VIF: 24.60)

▪ newbalanceDest (VIF: 41.07)

2. Outcome:
o After removing multicollinear features, the remaining features were independent
and relevant.

d. Correlation Analysis

1. Correlation with Target (isFraud):

o Derived features were analyzed for their correlation with the target variable:

▪ orig_balance_diff: 0.3568 (moderate positive correlation).

▪ orig_balance_ratio: 0.4839 (strong positive correlation).

▪ dest_balance_diff: -0.0499 (weak correlation; dropped).

▪ dest_balance_ratio: -0.0028 (negligible correlation; dropped).

2. Outcome:

o Only features with meaningful correlation (absolute correlation > 0.05) were
retained.

e. Final Feature Set

After the above steps, the final features included in the model were:

1. step: Transaction timestamp.

2. orig_balance_diff: Net change in origin account balance after the transaction.

3. log_amount: Log-transformed transaction amount.

4. log_orig_balance_ratio: Log-transformed ratio of origin account balances.
f. Justification for Variable Selection

1. Domain Knowledge:

o Engineered features like balance differences and ratios capture important

patterns of fraudulent behavior.

2. Statistical Relevance:

o Only features with low multicollinearity and meaningful correlation with the
target were retained.

3. Model Efficiency:

o Removing redundant and irrelevant features ensured faster training and better
generalization.

Summary

The variable selection process was rigorous, combining domain expertise, statistical techniques
(VIF and correlation), and feature engineering. This ensured the model used relevant,
independent, and predictive features for fraud detection.
4. Demonstration of Model Performance

The performance of the Random Forest fraud detection model was evaluated using standard
machine learning metrics and tools. Below is a detailed analysis of the evaluation process:

a. Evaluation Metrics

1. Classification Report:

o The classification_report provides detailed metrics such as precision, recall, and

F1-score for each class.

o Key metrics:

▪ Precision (Fraud, Class 1): 72%

▪ Indicates how many predicted fraud cases were actually fraud.

▪ Recall (Fraud, Class 1): 95%

▪ Measures the ability to identify actual fraud cases.

▪ F1-Score (Fraud, Class 1): 82%

▪ Balances precision and recall for fraud cases.

Classification Report:

precision recall f1-score support

0 1.00 1.00 1.00 1,906,322

1 0.72 0.95 0.82 2,464

accuracy 1.00 1,908,786

macro avg 0.86 0.97 0.91 1,908,786

weighted avg 1.00 1.00 1.00 1,908,786

2. Confusion Matrix:
o Visualized using a heatmap for better understanding of true positives, true
negatives, false positives, and false negatives.

o Output:

Confusion Matrix:
True Negatives (TN): 1,905,425

False Positives (FP): 897

False Negatives (FN): 124

True Positives (TP): 2,340

o Insights:

▪ The model has very high recall (low FN) for fraud detection.

▪ False positives are relatively low, minimizing unnecessary alerts for

legitimate transactions.

3. ROC-AUC Score:

o Score: 0.996

▪ Indicates excellent discriminatory ability between fraud and non-fraud

cases.

o A high ROC-AUC score reflects the model's ability to effectively rank fraud
probabilities.

b. Visualization Tools

1. Confusion Matrix Visualization:

o Demonstrates the breakdown of true/false positives and negatives in the dataset.

2. Feature Importance Visualization:

o Highlights which features contribute the most to fraud detection:

▪ log_orig_balance_ratio: Most significant feature.

▪ orig_balance_diff: Second most important.

▪ log_amount and step: Moderate and least important, respectively.

c. Strengths of the Model

1. High Recall for Fraud Cases:

o Recall of 95% ensures that most fraud cases are correctly identified, minimizing
losses due to undetected fraud.

2. High ROC-AUC Score:

o A score of 0.996 shows excellent discriminatory power, reflecting the model's

ability to differentiate between fraud and non-fraud cases.

3. Balanced Handling of Classes:

o Class imbalance was addressed using SMOTE, ensuring fair performance on both
classes.
d. Areas for Improvement

1. Precision for Fraud Cases:

o Precision of 72% for fraud cases indicates some legitimate transactions are
misclassified as fraud (false positives). This could be improved with:

▪ Hyperparameter tuning.

▪ Threshold adjustment to balance precision and recall.

2. Scalability:

o Although the model performs well, processing large datasets can be time-
consuming. Optimizations (e.g., using XGBoost or LightGBM) may improve
efficiency.

e. Tools Used

1. Scikit-learn:

o For metrics (classification_report, roc_auc_score), confusion matrix, and Random

Forest model training.

2. Seaborn & Matplotlib:

o For visualizing the confusion matrix and feature importance.

3. SMOTE (Imbalanced-learn):

o For handling class imbalance during model training.

Conclusion

The model demonstrated strong performance metrics, particularly in identifying fraud cases
(high recall and ROC-AUC). While the model is effective, further fine-tuning and scalability
improvements can enhance its practical application in real-time fraud detection systems.
5. Key Factors That Predict Fraudulent Customers

From the feature importance analysis of the Random Forest model, the key factors predicting
fraud are:

1. log_orig_balance_ratio:

o The most significant feature in predicting fraud.

o This is the log-transformed ratio of the original balance (oldbalanceOrg) to the

remaining balance after the transaction (newbalanceOrig).

o High values indicate that a significant proportion of the original balance is

transferred, which could signify fraudulent behavior.

2. orig_balance_diff:

o The second most important feature.

o This feature captures the net change in the origin account's balance before and
after the transaction.

o Large differences in the balance might indicate unusual or suspicious transaction

patterns.

3. log_amount:

o Represents the log-transformed transaction amount.

o Fraudulent transactions often involve unusually large or very small amounts,

which this feature helps to capture effectively after transformation.

4. step:

o Refers to the transaction's timestamp.

o While less significant than the other features, the timing of transactions (e.g.,
late at night or during off-peak hours) may provide clues to fraudulent activity.
6. Do These Factors Make Sense?

Yes, These Factors Make Sense. Here's Why:

1. log_orig_balance_ratio:

o Rationale:

▪ Fraudsters often deplete an account entirely or transfer a large

proportion of the available balance in a single transaction.

▪ This behavior is captured by the orig_balance_ratio, which shows the

proportion of the original balance involved in the transaction.

o Example:

▪ A legitimate user might retain some balance in their account after a

transaction, while a fraudster might transfer nearly all of it.

2. orig_balance_diff:

o Rationale:

▪ Large balance differences between oldbalanceOrg and newbalanceOrig

can indicate suspicious activity, especially when such changes are atypical
for the account.

▪ This is a direct indicator of how much money was moved in the

transaction.

o Example:

▪ A legitimate customer making regular, small transactions will have a

stable balance, while a fraudulent transaction might deplete the account
entirely.

3. log_amount:

o Rationale:
▪ Fraudulent transactions often involve extremes: either unusually high
amounts (to maximize gain in a single transaction) or unusually low
amounts (to avoid detection).

▪ Log transformation reduces skewness and makes patterns more

detectable for the model.

o Example:

▪ A fraudster might make a single transaction of an unusually large amount

compared to the customer's typical spending behavior.

4. step:
 o Rationale:

▪ Timing patterns can be indicative of fraud. For instance, fraudulent

transactions are more likely to occur at odd hours when account holders
are less likely to notice (e.g., late at night).

o Example:

▪ An unusual burst of transactions within a short time window might

signify fraud.

Further Validation of These Factors

These factors align with real-world patterns observed in fraudulent transactions:

• Fraudsters' Behavior:

o Fraudsters aim to maximize gains in a single transaction (high balance differences

and ratios).

o They operate when monitoring is less likely (specific time patterns).

• Statistical Evidence:

o Feature importance analysis confirms that these factors are the strongest
predictors of fraud in the dataset.

Are There Any Concerns?

1. Potential False Positives:

o Legitimate customers making large or unusual transactions (e.g., paying bills,

emergencies) might exhibit similar patterns and be flagged as fraud.

o Precision could be further improved by incorporating more contextual data about

transaction history or account behavior.

2. Simplistic Use of step:

o While the step feature captures transaction timing, additional temporal features
like transaction frequency or clustering similar transactions within time windows
could provide deeper insights.

Conclusion

The identified factors make intuitive sense and are backed by both statistical and domain-
specific reasoning. They effectively differentiate fraudulent from legitimate transactions, but
further refinement (e.g., additional features or contextual data) can enhance precision and
reduce false positives.
7. Prevention Strategies for Updating Company Infrastructure

To enhance fraud prevention and detection, companies should adopt the following measures
while updating their infrastructure:

a. Strengthen Data Security

1. Encryption:

o Encrypt sensitive customer data (e.g., account balances, personal information)

both in transit and at rest.

2. Multi-Factor Authentication (MFA):

o Implement MFA for all transactions, requiring customers to verify via multiple
channels (e.g., OTPs, biometrics).

3. Role-Based Access Control (RBAC):

o Restrict data access to authorized personnel only, minimizing insider threats.

b. Fraud Detection System

1. Real-Time Monitoring:

o Deploy fraud detection models (e.g., Random Forest) in real-time to analyze

transactions and flag suspicious activities instantly.

2. Behavioral Analysis:

o Track user behavior patterns over time and flag deviations (e.g., unusual
transaction amounts, locations, or frequencies).

3. Anomaly Detection:

o Use machine learning algorithms to identify outliers or patterns indicative of

fraud.

c. Infrastructure Improvements

1. Scalability:

o Use cloud-based infrastructure (e.g., AWS, Azure) to handle large volumes of

transaction data efficiently.

2. Automation:

o Automate routine checks for fraudulent patterns, such as frequent failed login
attempts or multiple high-value transactions.

3. Backup Systems:
 o Implement robust data backup solutions to ensure no data is lost in case of
cyberattacks or system failures.

d. Customer Awareness and Support

1. Education:

o Inform customers about common fraud tactics and encourage safe practices, like
not sharing credentials.

2. Fraud Reporting:

o Provide an easy-to-use platform for customers to report suspicious activity,

enabling quicker response.

e. Collaboration

1. Industry Partnerships:

o Collaborate with financial institutions and regulatory bodies to share fraud-

related data and insights.

2. Threat Intelligence:

o Stay updated on new fraud techniques through threat intelligence tools and
partnerships.
8. Determining if These Actions Work

To evaluate the effectiveness of these preventive measures, the company should adopt the
following assessment strategies:

a. Measure Key Performance Indicators (KPIs)

1. Reduction in Fraudulent Transactions:

o Compare the percentage of fraudulent transactions before and after

implementing the measures.

2. False Positive Rate:

o Track the number of legitimate transactions flagged as fraud to ensure customer

experience isn’t adversely impacted.

3. Customer Complaints:

o Monitor changes in the volume of fraud-related complaints or disputes.

b. Conduct Regular Audits

1. System Audits:

o Periodically assess the fraud detection system for accuracy, scalability, and
adaptability to new patterns.

2. Compliance Checks:

o Ensure the infrastructure complies with relevant data security regulations (e.g.,
GDPR, PCI DSS).

c. Analyze Model Performance

1. Model Metrics:

o Monitor precision, recall, and ROC-AUC of fraud detection models.

o Ensure consistent or improving performance over time.

2. Drift Detection:

o Use tools to detect data drift or model drift, indicating changes in transaction
patterns that may reduce model efficacy.

d. Customer Feedback

1. Surveys:
 o Conduct customer surveys to measure satisfaction with fraud detection and
resolution processes.

2. Support Metrics:

o Analyze metrics like average resolution time for fraud disputes and the number
of resolved cases.

e. Simulated Testing

1. Penetration Testing:

o Conduct ethical hacking exercises to identify vulnerabilities in the updated

infrastructure.

2. Simulated Fraud Scenarios:

o Test the fraud detection system using synthetic data to ensure robustness.

f. Continuous Improvement

1. Update Models:

o Retrain fraud detection models periodically with new data to ensure they remain
effective.

2. Iterative Enhancements:

o Implement incremental updates based on audit results and evolving fraud

tactics.

Conclusion

By adopting these preventive measures and continuously monitoring their effectiveness through
defined KPIs, audits, and customer feedback, the company can create a robust infrastructure
that minimizes fraud risks and ensures seamless customer experience.