Adverse selection and non-take inference with coherent risk and response scoring

R M Oliver and A M Thaker
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R M Oliver: University of California at Berkeley, Berkeley, CA, USA
A M Thaker: InfoCentricity, Inc., Novato, CA, USA

Journal of the Operational Research Society, 2013, vol. 64, issue 1, 70-85

Abstract: The authors offer a mathematical model for adverse selection by individual borrowers based on preferences for offers and the default (Bad) or non-default (Good) status of booked accounts. We define the condition for borrower risk and response when there is no adverse selection (NAS). This definition provides us with a direct comparison between the prior and posterior conditional probabilities of default by an individual borrower who Takes an offer; this allows us to obtain estimates of differential response rates for individual borrowers and the Good/Bad odds for Take, Non-Take and Accept sub-populations. Performance of different response-risk segments allows us to compare price-driven risk elasticity and price-driven response elasticity in the presence of Good or Bad adverse selections; a special case applies when the borrower's capacity to repay is not an issue. We offer limited experimental results for selected price-risk segments where action-based risk and response scores are used to estimate borrower preferences. The critical role of Non-Take inference is described.

Date: 2013
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