Consumer Credit Models Pricing, Profit and Portfolios

by Thomas, Lyn C.

• ISBN13: 9780199232130
• ISBN10: 019923213X
• Format: Hardcover
• Copyright: 2009-04-01
• Publisher: Oxford University Press

Summary

The use of credit scoring - the quantitative and statistical techniques to assess the credit risks involved in lending to consumers - has been one of the most successful if unsung applications of mathematics in business for the last fifty years. Now with lenders changing their objectives fromminimising defaults to maximising profits, the saturation of the consumer credit market allowing borrowers to be more discriminating in their choice of which loans, mortgages and credit cards to use, and the Basel Accord banking regulations raising the profile of credit scoring within banks thereare a number of challenges that require new models that use credit scores as inputs and extensions of the ideas in credit scoring. This book reviews the current methodology and measures used in credit scoring and then looks at the models that can be used to address these new challenges. The first chapter describes what a credit score is and how a scorecard is built which gives credit scores and models how the score is used in the lending decision. The second chapter describes the different ways the quality of a scorecard can be measured and points out how some of these measure thediscrimination of the score, some the probability prediction of the score, and some the categorical predictions that are made using the score.The remaining three chapters address how to use risk and response scoring to model the new problems in consumer lending. Chapter three looks at models that assist in deciding how to vary the loan terms made to different potential borrowers depending on their individual characteristics. Risk basedpricing is the most common approach being introduced. Chapter four describes how one can use Markov chains and survival analysis to model the dynamics of a borrower's repayment and ordering behaviour . These models allow one to make decisions that maximise the profitability of the borrower to thelender and can be considered as part of a customer relationship management strategy. The last chapter looks at how the new banking regulations in the Basel Accord apply to consumer lending. It develops models that show how they will change the operating decisions used in consumer lending and howtheir need for stress testing requires the development of new models to assess the credit risk of portfolios of consumer loans rather than a models of the credit risks of individual loans.

Author Biography

Lyn Thomas is Professor of Management Science at the School of Management at the University of Southampton and has for the last twenty five years been active as a researcher and consultant in the consumer credit area. He has co-authored and edited books and written over forty papers on consumer credit. He was the founder of the Credit Research Centre at the University of Edinburgh and has been joint organiser of the ten international Credit Scoring conferences. He is one of the principal investigators running the Quantitative Financial Risk Management Centre, a Past President of the Operational research Society, a consultant for several international financial organisations, and advisor to UK government departments. Professor Thomas is a Fellow of the Royal Society of Edinburgh, Institute of Mathematics and its Applications, and Operational Reseach Society.

Table of Contents

Acknowledgements	p. xiii
Introduction to consumer credit and credit scoring	p. 1
Introduction: importance and impact of consumer credit	p. 1
Historical background of default-based credit scoring	p. 5
Objectives of lenders	p. 9
Tools for modelling lending decisions: influence diagrams, decision trees, and strategy trees	p. 13
Probabilities, odds, information, and scores	p. 25
Modifying scores: scaling, multiple levels, and time dependency	p. 41
Lending returns and costs	p. 53
Fundamentals of scorecard building	p. 62
Using logistic regression to build scorecards	p. 79
Other scorecard-building approaches	p. 84
Measurement of scoring systems	p. 100
Measuring scorecard quality	p. 100
Discrimination measures: divergence, Kolmogorov-Smirnov statistic, and D-concordance statistic	p. 104
ROC curve and Gini coefficient	p. 115
Scorecard segmentation and measuring its impact on discrimination	p. 128
Calibration measures of scorecard probability predictions	p. 137
Measures of the correctness of categorical prediction	p. 146
Risk-based pricing	p. 152
Variable pricing in consumer lending	p. 152
Risk-free response rate function and optimal pricing	p. 152
Risk response relationship, adverse selection, and affordability	p. 169
Risk-based response function and risk-based pricing	p. 175
Acceptance scoring for multi-feature offers	p. 186
A borrower-lender game model for pricing	p. 196
Profit scoring and dynamic models	p. 204
Behavioural scoring and dynamic account management	p. 204
Profit scoring, risk/reward matrices to customer behaviour dynamics	p. 212
Markov chain models of account behaviour	p. 220
Markov decision process models of profitability	p. 237
Survival analysis-based scoring systems and default estimation	p. 251
Survival analysis-based profit models, including attrition and prepayment	p. 269
Portfolio credit risk and the Basel Accord	p. 278
Portfolio credit risk	p. 278
Economic and regulatory capital	p. 286
Summary of Basel Capital Accords	p. 289
Basel II regulations and their impact on credit scoring	p. 303
Regulatory capital and optimal cut-off policies	p. 314
Modelling credit risk for portfolios of consumer and corporate loans	p. 330
Basel stress testing of consumer portfolios: static and dynamic approaches	p. 347
Appendices	p. 360
Scores and runbook example	p. 360
Southampton bank application data	p. 362
References	p. 365
Index	p. 371
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