Profit scoring and dynamic models
Profit scoring and dynamic models
This chapter begins by reviewing the role of behavioural scoring and risk/reward matrices in the way a lender manages borrowers. It points out that current methods do not allow for the future changes in customer behaviour nor do they optimize the expected profit. It then shows how two approaches — Markov chain models and survival analysis ideas — can lead to dynamic profitability based models. In particular, the extension of Markov chains to Markov decision processes allows one to optimize decisions such as how to adjust the credit limit. In survival analysis, the proportional hazard models lead to hazard scores which play the same role as credit scores but work on all future performance periods. Moreover, the ideas of competing risk in survival analysis allows one to build profitability models that allow for default, prepayment, and attrition.
Keywords: behavioural score, risk/reward matrix, Markov chains, Markov decision processes, credit limit, survival analysis, proportional hazards, hazard score, competing risk, attrition
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