Interesting mechanism for detecting credit card fraud using hidden Markov model is described in IEEE Transactions on Dependable and Secure Computing, September 2007, (here). In conclusion, it says:
In this paper, we have proposed an application of Hidden Markov Model in credit card fraud detection. The different steps in credit card transaction processing are represented as the underlying stochastic process of an HMM. We have used the ranges of transaction amount as the observation symbols, while the types of item have been considered to be states of the HMM. We have suggested a method for finding the spending profile of cardholders as well as application of this knowledge in deciding the value of observation symbols and initial estimate of the model parameters. It has also been explained how the HMM can detect whether an incoming transaction is fraudulent or not. Experimental results show the performance and effectiveness of our system and demonstrate the usefulness of learning the spending profile of the cardholders. Comparative studies reveal that the Accuracy of the system is close to 80% over a wide variation in the input data. The system is also scalable for handling large volumes of transactions.
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