phase 4 : Artificial Intelligence- Project Development- Fraud

Detections in Financial Transactions

Introduction
Developing a fraud detection model for financial transactions involves several key stages, including
model development, selection of evaluation metrics, and finally, model selection. Here's an overview of
each stage:

1. Model Development:

 Data Collection and Preprocessing: Gather historical transaction data, including features
such as transaction amount, merchant ID, time of transaction, etc. Preprocess the data by
handling missing values, encoding categorical variables, and scaling numerical features.
 Feature Engineering: Create new features or transform existing ones that might help in
identifying fraudulent transactions. For example, calculating transaction frequency, average
transaction amount, or flagging transactions that deviate significantly from a user's typical
behavior.
 Model Training: Select an appropriate machine learning algorithm for anomaly detection, such
as Isolation Forest, One-Class SVM, or ensemble methods. Train the model on the preprocessed
data.
 Model Tuning: Fine-tune hyperparameters to optimize model performance. This can be done
using techniques like grid search or randomized search.

2. Evaluation Metrics:

 Precision, Recall, and F1-score: These metrics evaluate the model's ability to correctly identify
fraudulent transactions while minimizing false positives. Precision measures the proportion of
correctly identified frauds among all flagged transactions, recall measures the proportion of
correctly identified frauds among all actual frauds, and F1-score is the harmonic mean of
precision and recall.
 Accuracy: Measures the overall correctness of the model's predictions, considering both true
positives and true negatives.
 AUC-ROC: Area Under the Receiver Operating Characteristic curve measures the model's ability
to distinguish between fraud and legitimate transactions across different threshold settings.

3. Model Selection:
  Compare Performance: Evaluate each model using the selected evaluation metrics. Consider the
trade-offs between accuracy, novelty detection, and computational complexity.
 Select the Best Model: Choose the model that best aligns with project objectives and user
requirements. This could involve selecting the model with the highest F1-score, or considering a
combination of metrics based on the specific needs of the application.
 Iterate if Necessary: If none of the models meet the desired criteria, iterate by fine-tuning
parameters, exploring different algorithms, or preprocessing the data differently.
 By following these stages, one can develop an effective fraud detection model for financial
transactions, ensuring accurate identification of fraudulent activity while minimizing false
positives.

Algorithm selection
Certainly! Here's a simple Python program that demonstrates algorithm selection for fraud detection in
financial transactions. The program uses three different algorithms: Logistic Regression, Decision Tree,
and Random Forest. It selects the best algorithm based on performance metrics such as accuracy,
precision, recall, and F1-score.

To run this program, you'll need to have the following Python libraries installed:

pandas

numpy

scikit-learn

Lib file

pip install pandas numpy scikit-learn

Here’s the Python program:

import pandas as pd

import numpy as np

from sklearn.model_selection import train_test_split, cross_val_score

from sklearn.linear_model import LogisticRegression

from sklearn.tree import DecisionTreeClassifier

from sklearn.ensemble import RandomForestClassifier

from sklearn.metrics import accuracy_score, precision_score, recall_score, f1_score

def load_data():
 data = pd.DataFrame({

'feature1': np.random.randn(1000),

'feature2': np.random.randn(1000),

'feature3': np.random.randn(1000),

'feature4': np.random.randn(1000),

'fraud': np.random.randint(0, 2, 1000)

})

return data

def evaluate_model(model, X_train, X_test, y_train, y_test):

model.fit(X_train, y_train)

y_pred = model.predict(X_test)

accuracy = accuracy_score(y_test, y_pred)

precision = precision_score(y_test, y_pred)

recall = recall_score(y_test, y_pred)

f1 = f1_score(y_test, y_pred)

return accuracy, precision, recall, f1

data = load_data()

X = data.drop('fraud', axis=1)

y = data['fraud']

X_train, X_test, y_train, y_test = train_test_split(X, y, test_size=0.3, random_state=42)

models = {

'Logistic Regression': LogisticRegression(max_iter=1000),

'Decision Tree': DecisionTreeClassifier(),

'Random Forest': RandomForestClassifier()

}
results = {}

for name, model in models.items():

accuracy, precision, recall, f1 = evaluate_model(model, X_train, X_test, y_train, y_test)

results[name] = {

'Accuracy': accuracy,

'Precision': precision,

'Recall': recall,

'F1 Score': f1

for model_name, metrics in results.items():

print(f"Model: {model_name}")

for metric_name, metric_value in metrics.items():

print(f" {metric_name}: {metric_value:.4f}")

print()

best_model_name = max(results, key=lambda name: results[name]['F1 Score'])

best_model = models[best_model_name]

print(f"The best model is: {best_model_name} with an F1 Score of {results[best_model_name]['F1

best_model.fit(X_train, y_train)

final_predictions = best_model.predict(X_test)

output:
Model evaluation

Lib file

pip install pandas numpy scikit-learn

Python code

import pandas as pd

import numpy as np

from sklearn.model_selection import train_test_split

from sklearn.preprocessing import StandardScaler

from sklearn.ensemble import RandomForestClassifier

from sklearn.metrics import accuracy_score, precision_score, recall_score, f1_score, roc_auc_score,

def load_data():

data = pd.DataFrame({

'feature1': np.random.rand(1000),

'feature2': np.random.rand(1000),

'feature3': np.random.rand(1000),

'label': np.random.randint(0, 2, size=1000)

})

return data

def preprocess_data(data):

X = data.drop('label…

Evaluation metrics -- accuracy metrics

We will use the scikit-learn library to calculate these metrics

import numpy as np

from sklearn.metrics import accuracy_score, precision_score, recall_score, f1_score, roc_auc_score,

y_true = np.array([0, 1, 0, 0, 1, 0, 1, 1, 0, 1])

y_pred = np.array([0, 0, 0, 0, 1, 1, 1, 1, 0, 1])

y_pred_prob = np.array([0.1, 0.4, 0.2, 0.1, 0.9, 0.8, 0.7, 0.95, 0.3, 0.85]) # Predicted probabilities for
ROC AUC

accuracy = accuracy_score(y_true, y_pred)

print(f'Accuracy: {accuracy:.2f}')

precision = precision_score(y_true, y_pred)

print(f'Precision: {precision:.2f}')

recall = recall_score(y_true, y_pred)

print(f'Recall: {recall:.2f}')

f1 = f1_score(y_true, y_pred)

print(f'F1 Score: {f1:.2f}')

roc_auc = roc_auc_score(y_true, y_pred_prob)

print(f'ROC AUC: {roc_auc:.2f}')

conf_matrix = confusion_matrix(y_true, y_pred)

print(f'Confusion Matrix:\n{conf_matrix}')

fpr, tpr, _ = roc_curve(y_true, y_pred_prob)

roc_auc = auc(fpr, tpr)

plt.figure()

plt.plot(fpr, tpr, color='darkorange', lw=2, label=f'ROC curve (area = {roc_auc:.2f})')

plt.plot([0, 1], [0, 1], color='navy', lw=2, linestyle='--')

plt.xlim([0.0, 1.0])

plt.ylim([0.0, 1.05])

plt.xlabel('False Positive Rate')

plt.ylabel('True Positive Rate')

plt.legend(loc="lower right")

plt.show()

output:

Ranking metrics

Python code

import numpy as np

import pandas as pd

from sklearn.metrics import precision_score, average_precision_score, roc_auc_score

np.random.seed(42)

n_transactions = 1000

data = pd.DataFrame({

'transaction_id': range(1, n_transactions + 1),

'amount': np.random.rand(n_transactions) * 1000, # transaction amounts between 0 and 1000

})

data['fraud_score'] = np.random.rand(n_transactions)

data.loc[data['is_fraud'] == 1, 'fraud_score'] = np.random.rand(sum(data['is_fraud'])) * 0.5 + 0.5 #

data = data.sort_values(by='fraud_score', ascending=False).reset_index(drop=True)

def precision_at_k(y_true, y_scores, k):

"""Calculate Precision at K."""

order = np.argsort(y_scores)[::-1]

y_true = np.asarray(y_true)[order][:k]

return np.mean(y_true)

def mean_average_precision(y_true, y_scores):

"""Calculate Mean Average Precision (MAP)."""

return average_precision_score(y_true, y_scores)

def roc_auc(y_true, y_scores):

"""Calculate ROC AUC."""

return roc_auc_score(y_true, y_scores)

y_true = data['is_fraud'].values

y_scores = data['fraud_score'].values

p_at_10 = precision_at_k(y_true, y_scores, 10)

p_at_100 = precision_at_k(y_true, y_scores, 100)

map_score = mean_average_precision(y_true, y_scores)

roc_auc_score_val = roc_auc(y_true, y_scores)

print(f"Precision at 10: {p_at_10:.4f}")

print(f"Precision at 100: {p_at_100:.4f}")

print(f"ROC AUC: {roc_auc_score_val:.4f}")

output:

Diversity metrics

Python code

from sklearn.metrics import precision_score, recall_score, f1_score

def evaluate_diversity_metrics(true_labels, predicted_labels):

precision = precision_score(true_labels, predicted_labels)

recall = recall_score(true_labels, predicted_labels)

f1 = f1_score(true_labels, predicted_labels)

return precision, recall, f1

true_labels = [0, 1, 1, 0, 1, 0]

predicted_labels = [0, 1, 0, 0, 1, 1]

precision, recall, f1 = evaluate_diversity_metrics(true_labels, predicted_labels)

print("Precision:", precision)

print("Recall:", recall)

print("F1 Score:", f1)

Novelty metrics

Make sure you have scikit-learn installed (pip install scikit-learn).

Python code

from sklearn.metrics import precision_score, recall_score, f1_score

true_labels = [0, 1, 0, 0, 1, 1, 0, 0, 0, 1]

predicted_labels = [0, 0, 1, 0, 1, 1, 0, 1, 0, 1]

precision = precision_score(true_labels, predicted_labels)

recall = recall_score(true_labels, predicted_labels)

f1 = f1_score(true_labels, predicted_labels)

print("Precision:", precision)

print("Recall:", recall)

print("F1-score:", f1)

output:
Model selection

Sure, here's a Python code example that follows the steps outlined:

python

from sklearn.model_selection import train_test_split

from sklearn.metrics import precision_score, recall_score, f1_score, accuracy_score, roc_auc_score

from sklearn.ensemble import IsolationForest

from sklearn.svm import OneClassSVM

from sklearn.neighbors import LocalOutlierFactor

# Step 1: Choose Evaluation Metrics

evaluation_metrics = {

'Precision': precision_score,

'Recall': recall_score,

'F1-score': f1_score,

'Accuracy': accuracy_score,

'AUC-ROC': roc_auc_score

# Step 2: Train and Evaluate Models

X_train, X_test, y_train, y_test = train_test_split(X, y, test_size=0.2, random_state=42)

models = {

'Isolation Forest': IsolationForest(),

'One-Class SVM': OneClassSVM(),

'Local Outlier Factor': LocalOutlierFactor()

results = {}
for name, model in models.items():

model.fit(X_train)

y_pred = model.predict(X_test)

results[name] = {}

for metric_name, metric_func in evaluation_metrics.items():

if metric_name == 'AUC-ROC':

if name == 'Local Outlier Factor':

# AUC-ROC not applicable for Local Outlier Factor

results[name][metric_name] = None

else:

results[name][metric_name] = metric_func(y_test, y_pred)

else:

results[name][metric_name] = metric_func(y_test, y_pred)

for name, metrics in results.items():

print(f"Model: {name}")

for metric_name, value in metrics.items():

print(f"{metric_name}: {value}")

print()

best_model = max(results, key=lambda x: results[x]['F1-score'])

print(f"Best Model: {best_model}")

Make sure to replace X and y with your feature matrix and target vector respectively. This code trains
and evaluates three anomaly detection models (Isolation Forest, One-Class SVM, and Local Outlier
Factor) using various evaluation metrics. Finally, it selects the best model based on the F1-score.

Conclusion

In conclusion, the process of model selection for fraud detection in financial transactions involves
several key steps:

1. Choosing Evaluation Metrics: Defining evaluation metrics that align with project objectives and user
requirements, such as precision, recall, F1-score, accuracy, and AUC-ROC.

2. Training and Evaluating Models: Training different anomaly detection models, such as Isolation
Forest, One-Class SVM, and Local Outlier Factor, and evaluating their performance using the chosen
evaluation metrics.

3. Considering Trade-offs: Analyzing trade-offs between accuracy, diversity, and novelty. Models with
high accuracy may not necessarily excel in detecting novel fraud patterns, and vice versa.

4. Examining Performance Across Metrics: Comparing the performance of each model across all
evaluation metrics to understand their strengths and weaknesses.
5. Selecting the Best Model: Selecting the model that best balances the trade-offs and meets the
project objectives and user requirements. This could involve choosing the model with the highest F1-
score or considering a combination of metrics.

6. Iterating if Necessary: If none of the models meet the desired criteria, iterating by fine-tuning
parameters, exploring different algorithms, or preprocessing the data differently.

By following these steps, one can systematically evaluate and select the most suitable model for fraud
detection in financial transactions, considering both performance metrics and trade-offs.