1. Risk Solutions & Research © Copyright IBM Corporation 2005 Default Risk Modelling : Decision Tree Versus Logistic Regression Dr.Satchidananda S Sogala,Ph.D., Head, Risk Solutions & Research FSS, IBM India sasogala@in.ibm.com

2. IBM Financial Services © Copyright IBM Corporation 2005 | Agenda  Need for credit risk quantification  Uses of credit scoring model in credit analysis  Data mining approach to credit scoring  Comparing the Decision Trees with Logit Regression

3. IBM Financial Services © Copyright IBM Corporation 2005 | - Increase in market volatility - Emergence of new instruments for risk management - Integration of the credit markets globally - Availability of computing and analytical power and tools Need for Credit Risk Quantification

4. IBM Financial Services © Copyright IBM Corporation 2005 |  Objective tool for credit risk analysis  Can support scaling up  Particularly useful for standardized assets-based loans such as home loans, car loans  Default prediction Use of Credit Scoring Models

5. IBM Financial Services © Copyright IBM Corporation 2005 | Data Mining Process Data Feature selection Sampling Modeling Evaluation

6. IBM Financial Services © Copyright IBM Corporation 2005 | DM Approach to Creditscoring Data Feature selection Cluster prototypes Decision tree/Logit Evaluation 10 fold cross validation Classification accuracy True positive rate

7. Risk Solutions & Research © Copyright IBM Corporation 2005 Decision Trees VS Logit Regression Automatic feature selection Scalable Heterogeneous partitioning Intuitive graphical display Sequential feature selection Not scalable Homogeneous partitioning Assumes linear relations of log odds

8. Risk Solutions & Research © Copyright IBM Corporation 2005 Induced Rules from Decision Tree

9. Risk Solutions & Research © Copyright IBM Corporation 2005 Logistic Model

10. Risk Solutions & Research © Copyright IBM Corporation 2005 Features selected

11. Risk Solutions & Research © Copyright IBM Corporation 2005 Results

12. IBM Financial Services © Copyright IBM Corporation 2005 | Summary  Decision tree gave greater accuracy in identifying the true defaults (Lift of about 2)  More intuitive and less complex  Competitive pressures forcing operational sophistication  Use of cluster-based prototypes of non-defaulters for balancing the sample as the interest is in default

13. IBM Financial Services © Copyright IBM Corporation 2005 | THANK YOU THANK YOU FOR YOUR PATIENCE AND INTEREST!