New paper accepted for publication:
- T. Bellotti and J. Crook. Loss given default models incorporating macroeconomic variables for credit cards, International Journal of Forecasting, Article in Press 2011, Accepted Manuscript (available online).
Abstract
Loss Given Default is an important measure of credit loss used by financial institutions to compute risk within credit portfolios, expected loss on individual loans and capital requirements. The Basel II Capital Accord gives banks the opportunity to calculate their own estimates of Loss Given Default. Based on UK data for major retail credit cards, we build several models of Loss Given Default based on account level data including Tobit, a decision tree model, a Beta and fractional logit transformation. However, we find that Ordinary Least Squares models with macroeconomic variables perform best for forecast of Loss Given Default at account and portfolio level on independent hold-out data sets. The inclusion of macroeconomic conditions in the model is important since it provides a means to model Loss Given Default in downturn conditions as required by Basel II and enables stress testing.
