2
$\begingroup$

Does anyone know any events where using logistic regression to estimate probability of default has led to a bank, financial institution, government or anything really to benefit in practice?

I see a lot of journals, papers and theses on logistic regression used to estimate PD. Some develop models, and some validate. But how many actually prove beneficial in practice?

Motivation: For a mathematical finance project, I have to convince a bank, financial institution or government to even entertain the idea of using probabilities of default coming from logistic regression. Theoretical justifications or predictions won't do. It has to be good effects that actually come from using the PDs. Like, model was implemented then it turned out great (Never mind The Black Swan for now).

The project is already complete but utterly pointless outside a bookshelf for future research if the bank/FI/govt doesn't choose to implement it.

I am looking for not necessarily a journal, paper or thesis. It could be a news or magazine article or something, anything really.

$\endgroup$
  • $\begingroup$ Assuming that anybody actually found any such benefits I believe it is unlikely to show up in research or media soon. And even if, how would you rate a single observation against the unknown population size of users who tried? If you really want to resolve this, I suggest that you run a survey. $\endgroup$ – RndmSymbl Feb 21 '15 at 14:49
  • $\begingroup$ @RndmSymbl Thanks. Well it's the bank's responsibility to realize that it's just one success out of millions of trials. youtube.com/watch?v=9R5OWh7luL4 Survey among whom? P.S. Again, Never mind The Black Swan for now >:) $\endgroup$ – BCLC Feb 21 '15 at 16:55
  • $\begingroup$ Short of actual observation the suggested approach by Quantopic seems reasonable, maybe you could compare against regulatory standard models if you only have a few days to do the work and outline any limitations of the comparison?P.S.: If you want to survey, ask the banks. Most regulators publish a list of regulated entities $\endgroup$ – RndmSymbl Feb 22 '15 at 17:19
5
+50
$\begingroup$

Firstly, the use of the logit models to estimate the PDs is particularly appreciated in some credit industries, as, for instance, the credit retail one. The logit model predicts pretty well the PD on loans, consumer credit, credit cards, ... and all concerns the retail consumer world.

Mainly, those listed are the principal sub-industries in the credit business where the logit model works fine.

In the others, the logit model does not work. The most famous case is the PD estimate of low-default-portfolios, in which there are so fews defaults that's impossible to estimate the probability of default by using a logit model; the government bond portfolios are an example of those ones.

Secondly, I suggest to look at the benefits of those kinds of model in terms of money saved by the bank; as you probably know, generally a bank has to estimate the probability of default about own credit exposures in order to be able to set aside the right quantity of money to satisfy capital requirements according to the Basel III treaty.

As more the PD estimates about the bank credit exposures are accurate, as more the bank saves money (required capital).

This is the main reason the bank wants to estimate properly PD, EAD, LGD,... because, in this way, by showing to the Supervisor it can develop a model correctly and in a better way than the model suggested by the regulators, the bank can set aside less money in terms of capital requirements and, so, to invest money in the business.

Now, in order to show to the bank why it should use those kind of model, you should estimate the different models suggested by the literature:

  1. Logistic model;
  2. Probit model;
  3. Neural networks;

and compare them to see which model allows you, at the same time, to save money in terms of capital requirements and make money in terms of business. In fact, the money you set aside for the capital requirements cannot be used by the banks for business (the bank cannot use that money to issue, for example, a loan).

Thirdly, there is no articles, papers or something like this on which you can base your answer for the project work, because this topic is relatively new and the academic literature is still debatable about that. I suggest to provide your own (reasonable) considerations about the issue.

$\endgroup$
  • $\begingroup$ Thanks Quantopic. #2 Daaaaamn. I wish I thought of this at the start of the project! The report is in a few days. How would you argue with only 1 model (logit/logistic)? Do you know if it has proved more efficient (read: less expensive) than others in any papers or something? $\endgroup$ – BCLC Feb 22 '15 at 14:18
  • $\begingroup$ As I wrote above down, the issue is particularly dibated and there's not some paper that suggests which model is better. Anyway, the most used in the academic literature and by practioners is the logistic one. Look researchgate.net/profile/Lyn_Thomas2/publication/… for some help! $\endgroup$ – Quantopik Feb 22 '15 at 18:40

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.