Statistical aspects of credit scoring

Henley, William Edward (1995). Statistical aspects of credit scoring. PhD thesis The Open University.



This thesis is concerned with statistical aspects of credit scoring, the process of determining how likely an applicant for credit is to default with repayments. In Chapters 1-4 a detailed introduction to credit scoring methodology is presented, including evaluation of previous published work on credit scoring and a review of discrimination and classification techniques.

In Chapter 5 we describe different approaches to measuring the absolute and relative performance of credit scoring models. Two significance tests are proposed for comparing the bad rate amongst the accepts (or the error rate) from two classifiers.

In Chapter 6 we consider different approaches to reject inference, the procedure of allocating class membership probabilities to the rejects. One reason for needing reject inference is to reduce the sample selection bias that results from using a sample consisting only of accepted applicants to build new scorecards. We show that the characteristic vectors for the rejects do not contain information about the parameters of the observed data likelihood, unless extra information or assumptions are included. Methods of reject inference which incorporate additional information are proposed.

In Chapter 7 we make comparisons of a range of different parametric and nonparametric classification techniques for credit scoring: linear regression, logistic regression, projection pursuit regression, Poisson regression, decision trees and decision graphs. We conclude that classifier performance is fairly insensitive to the particular technique adopted.

In Chapter 8 we describe the application of the k-NN method to credit scoring. We propose using an adjusted version of the Eucidean distance metric, which is designed to incorporate knowledge of class separation contained in the data. We evaluate properties of the k-NN classifier through empirical studies and make comparisons with existing techniques.

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