Estimating Credit Risk Parameters Using Ensemble Learning Methods: An Empirical Study on Loss Given Default

27 Pages Posted: 11 Aug 2016

See all articles by Han Sheng Sun

Han Sheng Sun

Global Risk Management Network, LLC

Zi Jin

Wells Fargo Bank

Date Written: August 9, 2016

Abstract

In credit risk modeling, banks and insurance companies routinely use a single model for estimating key risk parameters. Combining several models to make a final prediction is not often considered. Using an ensemble or a collection of models rather than a single model can improve the accuracy and robustness of prediction results. In this study, we investigate two well-established ensemble learning methods (stochastic gradient boosting and random forest) and propose two new ensembles (ensemble by partial least squares and bag-boosting) in the application of predicting the loss given default. We demonstrate that an ensemble approach significantly increases the discriminatory power of the model compared with a single decision tree. In addition, the ensemble learning methods can be applied directly to predicting the exposure at default and probability of default with some simple modifications. The proposed approaches introduce a novel modeling framework that banks and other financial institutions can use to estimate and validate credit risk parameters based on the internal data of different portfolios. Moreover, the proposed approaches can be readily extended to general portfolio risk modeling in the areas of regulatory capital and economic capital management, loss forecasting, stress testing and pre-provision net revenue projections.

Keywords: ensemble learning methods, loss given default, stochastic gradient boosting, random forest, partial least squares algorithm, discriminatory power

Suggested Citation

Sheng Sun, Han and Jin, Zi, Estimating Credit Risk Parameters Using Ensemble Learning Methods: An Empirical Study on Loss Given Default (August 9, 2016). Journal of Credit Risk, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2820572

Han Sheng Sun (Contact Author)

Global Risk Management Network, LLC ( email )

Cornell Business and Technology Park
Ithaca, NY 14852-4892
United States

Zi Jin

Wells Fargo Bank ( email )

United States

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