Visualization is a great way to get an overview of credit modeling. Typically, you will start by making data management and data cleaning, and after this, your credit modeling analysis will start with visualizations. This article is, therefore, the first part of a credit machine learning analysis with visualizations. The second part of the analysis will typically use logistic regression and ROC curves.
Introduction to Credit Modelling
Credit modelling is the best way for lenders to understand how likely a particular loan is to get repaid. In other words, it’s a tool to understand the credit of a borrower. This is especially important because this credit profile keeps changing with time and circumstances.
There are many different factors that affect a person’s credit situation. This makes assessing a borrower’s credit a highly complex task. With so much money riding on our ability to accurately estimate the credit of a borrower, credit modeling has come into the picture.
Credit modelling refers to the process of using data models to find out two important things. The first is the probability of the borrower defaulting on the loan. The second is the impact on the financials of the lender if this default occurs.
Financial institutions rely on credit models to determine the credit of potential borrowers. They make decisions on whether or not to sanction a loan, as well as on the interest rate of the loan based on the credit model validation.
As technology has progressed, new ways of modeling credit have emerged, including credit modelling using R. These include using the latest analytics and big data tools to model credit. Other factors like the evolution of economies and the subsequent emergence of different types of credit have also impacted how credit modelling is done.
Credit Modelling in R
Now let us start using R for Credit Modelling:
Library of R packages
In the following section we will use R for visualization of credit modelling. First we read the packages into the R library:
Load dataset and data management
#Data management packages
# Visualization packages
Next it is time to read the dataset and do some data management. We use the lending club loan dataset:
Read the dataset into R library
loan <- read.csv(“/loan.csv”)
Data management of the dataset
loan$member_id <- as.factor(loan$member_id)
loan$grade <- as.factor(loan$grade)
loan$sub_grade <- as.factor(loan$sub_grade)
loan$home_ownership <- as.factor(loan$home_ownership)
loan$verification_status <- as.factor(loan$verification_status)
loan$loan_status <- as.factor(loan$loan_status)
loan$purpose <- as.factor(loan$purpose)
Visit DataScience+ Blog to download the complete code on data selection and data cleaning.
In the second part of this article, Kristian will demonstrate how to create the visualizations for credit modeling
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from DataScience+ and is being posted with permission from DataScience+. The views expressed in this material are solely those of the author and/or DataScience+ and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.