The construction of empirical credit scoring rules based on maximization principles

Robert P. Lieli*, Halbert White

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract (may include machine translation)

We examine the econometric implications of the decision problem faced by a profit/utility-maximizing lender operating in a simple "double-binary" environment, where the two actions available are "approve" or "reject", and the two states of the world are "pay back" or "default". In practice, such decisions are often made by applying a fixed cutoff to the maximum likelihood estimate of a parametric model of the default probability. Following (Elliott and Lieli, 2007), we argue that this practice might contradict the lender's economic objective and, using German loan data, we illustrate the use of "context-specific" cutoffs and an estimation method derived directly from the lender's problem. We also provide a brief discussion of how to incorporate legal constraints, such as the prohibition of disparate treatment of potential borrowers, into the lender's problem.

Original languageEnglish
Pages (from-to)110-119
Number of pages10
JournalJournal of Econometrics
Volume157
Issue number1
DOIs
StatePublished - Jul 2010
Externally publishedYes

Keywords

  • Binary variables
  • Credit scoring
  • Profit maximization

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