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Benchmarking regression algorithms for loss given default modeling

Benchmarking regression algorithms for loss given default modeling
Benchmarking regression algorithms for loss given default modeling
The introduction of the Basel II Accord has had a huge impact on financial institutions, allowing them to build credit risk models for three key risk parameters: PD (probability of default), LGD (loss given default) and EAD (exposure at default). Until recently, credit risk research has focused largely on the estimation and validation of the PD parameter, and much less on LGD modeling. In this first large-scale LGD benchmarking study, various regression techniques for modeling and predicting LGD are investigated. These include one-stage models, such as those built by ordinary least squares regression, beta regression, robust regression, ridge regression, regression splines, neural networks, support vector machines and regression trees, as well as two-stage models which combine multiple techniques. A total of 24 techniques are compared using six real-life loss datasets from major international banks. It is found that much of the variance in LGD remains unexplained, as the average prediction performance of the models in terms of R2 ranges from 4% to 43%. Nonetheless, there is a clear trend that non-linear techniques, and in particular support vector machines and neural networks, perform significantly better than more traditional linear techniques. Also, two-stage models built by a combination of linear and non-linear techniques are shown to have a similarly good predictive power, with the added advantage of having a comprehensible linear model component.

0169-2070
161-170
Loterman, G.
87bb0c85-8b43-49bf-92d7-4d894d4bb3aa
Brown, I.
13b13988-789f-40e2-a2d8-8f326f68eedd
Martens, D.
cda8c1d8-591a-402b-a8c4-800a02979bd7
Mues, C.
07438e46-bad6-48ba-8f56-f945bc2ff934
Baesens, B.
f7c6496b-aa7f-4026-8616-ca61d9e216f0
Loterman, G.
87bb0c85-8b43-49bf-92d7-4d894d4bb3aa
Brown, I.
13b13988-789f-40e2-a2d8-8f326f68eedd
Martens, D.
cda8c1d8-591a-402b-a8c4-800a02979bd7
Mues, C.
07438e46-bad6-48ba-8f56-f945bc2ff934
Baesens, B.
f7c6496b-aa7f-4026-8616-ca61d9e216f0

Loterman, G., Brown, I., Martens, D., Mues, C. and Baesens, B. (2012) Benchmarking regression algorithms for loss given default modeling. International Journal of Forecasting, 28 (1), 161-170. (doi:10.1016/j.ijforecast.2011.01.006).

Record type: Article

Abstract

The introduction of the Basel II Accord has had a huge impact on financial institutions, allowing them to build credit risk models for three key risk parameters: PD (probability of default), LGD (loss given default) and EAD (exposure at default). Until recently, credit risk research has focused largely on the estimation and validation of the PD parameter, and much less on LGD modeling. In this first large-scale LGD benchmarking study, various regression techniques for modeling and predicting LGD are investigated. These include one-stage models, such as those built by ordinary least squares regression, beta regression, robust regression, ridge regression, regression splines, neural networks, support vector machines and regression trees, as well as two-stage models which combine multiple techniques. A total of 24 techniques are compared using six real-life loss datasets from major international banks. It is found that much of the variance in LGD remains unexplained, as the average prediction performance of the models in terms of R2 ranges from 4% to 43%. Nonetheless, there is a clear trend that non-linear techniques, and in particular support vector machines and neural networks, perform significantly better than more traditional linear techniques. Also, two-stage models built by a combination of linear and non-linear techniques are shown to have a similarly good predictive power, with the added advantage of having a comprehensible linear model component.

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More information

Published date: 2012
Organisations: Southampton Business School

Identifiers

Local EPrints ID: 204749
URI: http://eprints.soton.ac.uk/id/eprint/204749
ISSN: 0169-2070
PURE UUID: b754b8be-5bdd-4663-ab8f-fa486e1f89a3
ORCID for B. Baesens: ORCID iD orcid.org/0000-0002-5831-5668

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Date deposited: 30 Nov 2011 09:55
Last modified: 17 Dec 2019 01:47

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Contributors

Author: G. Loterman
Author: I. Brown
Author: D. Martens
Author: C. Mues
Author: B. Baesens ORCID iD

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