Loss given default models incorporating macroeconomic variables for credit cards

Loss given default models incorporating macroeconomic variables for credit cards

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Article ID: iaor20133252
Volume: 28
Issue: 1
Start Page Number: 171
End Page Number: 182
Publication Date: Jan 2012
Journal: International Journal of Forecasting
Authors: ,
Keywords: forecasting: applications
Abstract:

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. We find that Ordinary Least Squares models with macroeconomic variables perform best for forecasting Loss Given Default at the account and portfolio levels 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. We find that bank interest rates and the unemployment level significantly affect LGD.

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