Consumer Credit Risk Models Via Machine-Learning Algorithms

49 Pages Posted: 13 Mar 2010 Last revised: 28 Mar 2010

See all articles by Amir Khandani

Amir Khandani

Massachusetts Institute of Technology (MIT)

Adlar J. Kim

Massachusetts Institute of Technology (MIT)

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Date Written: March 11, 2010

Abstract

We apply machine-learning techniques to construct nonlinear nonparametric forecasting models of consumer credit risk. By combining customer transactions and credit bureau data from January 2005 to April 2009 for a sample of a major commercial bank's customers, we are able to construct out-of-sample forecasts that significantly improve the classification rates of credit-card-holder delinquencies and defaults, with linear regression R-squared's of forecasted/realized delinquencies of 85%. Using conservative assumptions for the costs and benefits of cutting credit lines based on machine-learning forecasts, we estimate the cost savings to range from 6% to 25% of total losses. Moreover, the time-series patterns of estimated delinquency rates from this model over the course of the recent financial crisis suggests that aggregated consumer-credit risk analytics may have important applications in forecasting systemic risk.

Keywords: Household Behavior, Consumer Credit Risk, Risk Management, Credit Card Borrowing, Machine Learning, Nonparametric Estimation

JEL Classification: G21, G33, G32, G17, G01, D14

Suggested Citation

Khandani, Amir E. and Kim, Adlar J. and Lo, Andrew W., Consumer Credit Risk Models Via Machine-Learning Algorithms (March 11, 2010). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1568864 or http://dx.doi.org/10.2139/ssrn.1568864

Amir E. Khandani

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Adlar J. Kim

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
1,051
Abstract Views
3,825
rank
20,095
PlumX Metrics