Variational Autoencoder

Updated on March 12, 2024
Article byKhalid Ahmed
Edited byRaisa Ali
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Variational Autoencoder (VAE)?

Variational autoencoders (VAEs) are probabilistic models focusing on finding low-dimensional, latent data representations. They capture a dataset’s probability distribution and generate new samples. They use an encoder-decoder mechanism as part of their architecture, and they use deep learning to aid in this process.

Variational Autoencoder

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The models of variational autoencoders for anomaly detection can understand the underlying data distribution and produce new samples that follow the same distribution. This is because they are designed to minimize the differences between the originally collected and reconstructed data. Also, the technique helps to keep maximum information while encoding and reduces reconstruction errors. 

Key Takeaways

  • Variational autoencoders (VAEs) employ an encoder-decoder mechanism and leverage deep learning techniques to minimize the differences between the original and reconstructed data. This approach ensures the preservation of maximum information while reducing reconstruction errors.
  • Variational autoencoder applications in finance include fraud detection and portfolio optimization.
  • VAEs offer several advantages, including their ability to model realistic financial scenarios, handle noise and missing data, and contribute to risk management and decision-making processes. 
  • Disadvantages include costly training on large and complex financial datasets. Additionally, skewed or unrealistic scenarios, etc., can be generated.

Variational Autoencoder In Finance Explained

Variational autoencoder is a generative model representing a data distribution using independent latent variables. It uses both observed and latent variables. A VAE comprises two networks: an encoder network that converts input data into a latent code and a decoder network that performs the inverse process, converting the latent code back into reconstruction data. Through this training process, the VAE acquires an optimal latent expression that captures the essential properties of the data, allowing for accurate reconstruction.

The VAE can comprehend the distribution of data and produce new samples that are consistent with it by minimizing the difference between the original and reconstructed data. VAEs can produce new data samples that closely resemble the training set. Its generation of fresh data points that smoothly interpolate with the data used for training is made possible by its continuous latent space. These tools have been utilized to create images, achieve advanced results in semi-supervised learning, and interpolate between sentences. Variational autoencoder applications also find utility in text generation and density estimation.

In finance, variational autoencoders for anomaly detection are useful for fraud detection and portfolio optimization. They can be used to discover patterns in asset returns, create new scenarios to mimic market conditions and improve portfolio allocation strategies. They can also pick up patterns in normal financial transactions by training on a large dataset of authentic transactions. With this information, abnormal transactions that point to fraud can be found.


Let us look into a few examples to understand the concept better:

Example #1

An investor named Daisy is considering employing a Variational Autoencoder (VAE) to identify fraudulent stock trading transactions. VAEs can be trained to recognize typical patterns and dependencies using a sizable real transaction dataset. VAEs can recognize abnormal or fraudulent transactions by comparing learned normal behavior to new transactions. They are able to spot minute deviations from the usual trading patterns that can point to fraud.

VAEs can also pick up interpretable latent space representations, which allow them to provide insights into the fundamental causes of fraudulent transactions. Daisy can improve her capacity to recognize and counteract fraudulent activity in stock trading by utilizing the power of VAEs.

Example #2

This study explored the use of neural networks, specifically variational autoencoders (VAEs), to augment sample sizes in clinical studies and reduce the need for many participants. The researchers developed an appropriate VAE architecture and fine-tuned hyperparameters such as hidden layers, functions, epochs, neurons per layer, and weights. The VAE model was then applied in simulated Monte Carlo clinical studies, considering various scenarios with different average performances, high endpoint variability, and subsampled group sizes.

The results showed that the VAE-generated data had increased statistical power, particularly in cases with high variability. The VAE method maintained a low type I error rate and even achieved a lower type II error rate than the original datasets. The combination of VAEs with Monte Carlo simulated clinical trials demonstrated desirable performance, reducing human exposure in studies, significant cost savings, and shorter trial completion times.

Advantages And Disadvantages

Let us look into the advantages and disadvantages of variational autoencoders in deep learning:


  1. VAEs are useful for modeling and creating realistic financial scenarios and can reflect variances in financial data.
  2. They are probabilistic models that can be useful for managing risks and making decisions.
  3. VAEs can produce the intended result since they can handle noise and missing data in the input.
  4. Financial data’s underlying causes can be better understood because VAEs can learn interpretable latent space representations.


  1. Training VAEs can be costly, particularly when dealing with big and complicated financial datasets.
  2. There is a chance of producing skewed or unrealistic scenarios, and the quality of the generated samples can differ.
  3. It can be difficult to interpret the learned latent space representations.
  4. VAEs may not function well when there is a lack of training data or when the distribution of the data varies considerably over time.

Variational Autoencoder vs Autoencoder vs GAN(Generalized Adversarial Networks)

Let us look into the differences between the concepts:

BasisVariational AutoencoderAutoencoderGAN
 VAE is a type of autoencoder where the encoding distribution is regularized. The model ensures its latent space has desirable properties during training, allowing for the generation of new data.  Autoencoder models find optimal encoding-decoding schemes through iterative optimization. They work by setting an encoder and decoder as neural networks.  Generalized Adversarial Networks (GANs) are generative models that are trained simultaneously on generator and discriminator networks in a competitive process that teaches them to produce realistic data.   
EssenceVAE learns to encode the given input and then reconstructs it from the encoding.    They are special neural networks that learn the replication of given information.A GAN works to generate new data that can’t be distinguished from real data.
Feature learning   VAE’s unsupervised learning models and is suitable for feature learning.  Autoencoders are unsupervised learning models and are suitable for feature learning.GAN’s random initialization can lead to unpredictable feature learning trajectories, potentially limiting its suitability for feature learning.

Frequently Asked Questions (FAQs)

1. What are the applications of variational autoencoders?

Variational autoencoders in deep learning are utilized in various fields, such as image generation, natural language processing, finance, and healthcare. They are used for data generation, anomaly detection, and representation learning.

2. What is the importance of variational autoencoders (VAEs) in AI?

 VAEs are a type of neural network design in AI that combines variational inference and autoencoders. A decoder network reconstructs the original data, while an encoder network maps input data to a latent space. In order to capture model uncertainty, VAEs add a probabilistic component.

3. When to use variational autoencoders?

VAEs are effective when handling complex, high-dimensional data with hidden structures or dependencies, capturing uncertainty, and generating data for unsupervised representation learning. They have proven successful in anomaly detection, latent space exploration, text and image generation, and handling noisy or incomplete input.

4. Is VAE supervised or unsupervised?

Variational Autoencoders (VAEs) are unsupervised learning models that don’t require labeled data during training.

This article has been a guide to what is Variational Autoencoder. We compare it with autoencoder and GAN, and explain its examples, advantages, and disadvantages. You may also find some useful articles here –

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