Modelling the profitability of credit cards by Markov decision processes

Modelling the profitability of credit cards by Markov decision processes

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Article ID: iaor20113905
Volume: 212
Issue: 1
Start Page Number: 123
End Page Number: 130
Publication Date: Jul 2011
Journal: European Journal of Operational Research
Authors: ,
Keywords: markov processes, programming: markov decision
Abstract:

This paper derives a Markov decision process model for the profitability of credit cards, which allows lenders to find an optimal dynamic credit limit policy. The states of the system are based on the borrower’s behavioural score and the decisions are what credit limit to give the borrower each period. In determining which Markov chain best describes the borrower’s performance, second order as well as first order Markov chains are considered and estimation procedures developed that deal with the low default levels that may exist in the data. A case study is given in which the optimal credit limit is derived and the results compared with the actual outcomes.

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