You’ve been tasked with building a classification machine-learning model to predict whether a transaction is either fraud or not fraud for a credit card company. You have ten years of historical data on transactions, including a flag for whether a transaction was manually identified as fraud.

Describe how you might go about building a fraud detection model for credit card transactions. Be sure to mention the possible model types, discuss the bias-variance tradeoff in model development, and address any complexities that arise from the class imbalance.

Input features in the data include:

<ul>
<li>Transaction amount</li>
<li>Merchant category for the transaction</li>
<li>Zip code for the merchant</li>
<li>Zip code for the billing address</li>
<li>Average transaction amount for the account over the past six months</li>
</ul>

Output feature:

<ul>
<li>0/1 flag for fraud (0 = not fraud, 1 = fraud)</li>
</ul>

Note: Fraudulent transactions are (thankfully) a very small percentage of all historical transactions. Assume fraudulent transactions are 0.01% of historical data.While building the model to perform the classification, you need to consider the bias/variance tradeoff, and take into account the fact that there is a class imbalance (very few of the observations are “fraud”).

Bias variance tradeoff and class imbalance in finance

Bias - Variance Tradeoff and Class Imbalance in Finance

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