Transition Matrix Models of Consumer Credit Ratings
27 Pages Posted: 27 Jan 2010
Date Written: January 27, 2010
The corporate credit risk literature has many studies modelling the change in the credit risk of corporate bonds over time. There is far less analysis of the credit risk for portfolios of consumer loans. However behavioural scores, which are commonly calculated on a monthly basis by most consumer lenders are the analogues of ratings in corporate credit risk. Motivated by studies in corporate credit risk, we develop a Markov chain model based on behavioural scores to establish the credit risk of portfolios of consumer loans. However such a consumer credit model differs in many respects from corporate credit ones based on Markov chains – the need for a second order Markov chain, the inclusion of economic variables and the age of the loan. The model is applied using data on a credit card portfolio from a major UK bank.
Keywords: Markov chain, Credit risk, Logistic regression, Credit scoring
JEL Classification: C25, G21, G33
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