Profit-based credit models with lender’s attitude towards risk and loss

Edwin Baidoo and Ramachandran Natarajan

Journal of Behavioral and Experimental Finance, 2021, vol. 32, issue C

Abstract: Profit scoring represents a shift from default risk modeling. Here, lenders align their lending strategies to reflect their profitability objective. This paper proposes models that address the lender’s profit maximization objective. We develop varying cutoff functions that inform lending decisions while considering a lender’s attitude towards risk and loss. We derive two propositions about the properties of the variable cutoff functions for risk-averse and loss-averse lenders. Using a proprietary consumer loan data set, we show the effect of cutoff functions in lending decisions and find that both risk-averse and loss-averse lenders are profitable if they use parameter estimators that support their profitability objective.

Keywords: Credit scoring; Profit scoring; Risk-aversion; Loss-aversion; Prospect theory; Cumulative prospect theory (search for similar items in EconPapers)
JEL-codes: C60 D12 G51 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:beexfi:v:32:y:2021:i:c:s2214635021001222

DOI: 10.1016/j.jbef.2021.100578

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