Author Topic: Masters Project on "Determinants of Loan Default"  (Read 8058 times)

edward

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Masters Project on "Determinants of Loan Default"
« on: May 22, 2013, 10:25:19 PM »
http://www.tumblr.com/tagged/peter%20klibowitz

Masters Project on "Determinants of Loan Default: A Closer Look at Peer-to-Peer Loans" (2011)

I noted the author's misconception about "public records," thinking they meant criminal records. I enjoyed it for portions I could understand about which factors tend to correlate with defaults but know nothing about the statistics.

Hope those with statistical background can help the rest of us better understand more about the significance of the conclusions he presents and your thoughts on the conclusions.

We'd all like to better understand how to reduce our defaults, and I thought this paper might add one more dimension to the great discussions on this forum.   


New Jersey Guy

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Re: Masters Project on "Determinants of Loan Default"
« Reply #1 on: May 22, 2013, 11:42:59 PM »
This is a Masters Paper?  A 12th grader could have come up with the same conclusions with a lot less big words.

Here is what he concluded:
"An investor should first focus on a borrower’s loan interest rate and FICO score.  Holding all other risks factors constant, we would recommend 60-month loans over 30-month loans if default risk were a concern to the investor.  We’d also recommend focusing on larger loans, as they are less likely to default when compared to smaller loans. Finally we offer the fairly intuitive suggestions of preferring loans where the borrower makes a larger monthly income, is employed, and is older or has a longer credit history."

So, in plain New Jersey Guy language, this is what he's telling me: Invest in the old(er) guy who has a good FICO, has a job, makes a good income, and wants to borrow over $25K.  Well, gee Mr. Einstein, thanks for setting that record straight!

What leads to default?  How about factoring some of these situations into the model
Oklahoma tornado
Hurricane Sandy
Terrorist attack
Loss of job
Possible disability
divorce
Heart attack
Stroke
Falling off a ladder and breaking your back
Death

The point I'm making is that unless we ask every borrower who defaults what happened, we have no clue as to what led to the default.  Granted, his recommendations could be construed as better risks, but that's no new discovery.  However,  Everybody here has chosen notes that you thought were flawless only to be putting them up on Folio 8 months later.   I've seen notes where 740 scores default, and 660 scores not miss a beat.

So, what happened?  Life happened.  And those are variables that can never be put into any model. 
Return over deposits:   66.82%
IRR:   86.54%
As of April 30, 2014

LonghornSF

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Re: Masters Project on "Determinants of Loan Default"
« Reply #2 on: May 22, 2013, 11:52:35 PM »
Here's a link for those of us without Tumblr:

http://www.peterklibowitz.com/portfolio.html


I think the paper is pretty low quality. On top of numerous spelling and grammatical mistakes, there are several major factual mistakes. For example, the author refers to 30 month loans on LC, states that the DTI ratio measures total debt to income (reality: it measures debt service to income), and thinks that public records measures the number of crimes committed. I also think it's a mistake to assign homeowners the same value as a homeowners with a mortgage. All these rather basic factual mistakes call into question the rest of his work.

core

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Re: Masters Project on "Determinants of Loan Default"
« Reply #3 on: May 23, 2013, 12:48:46 AM »
I think the best determinant of loan default is the borrower's inability to pay.  =)

But that's why I don't have a PhD.  This Einstein needs to come trade with me on the platform instead of hiding in academia, probably going into more debt himself.

AnilG

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Re: Masters Project on "Determinants of Loan Default"
« Reply #4 on: May 23, 2013, 01:20:47 AM »
If I was grading his Masters Paper, I will give him an 'D' for the two recommendations he mentioned. This is what happens when people analyze data without understanding the underlying raw data and context. A basic data exploration would have told him that not enough time has passed since LC started issuing 60 month loans and loans greater than $25,000 for both recommendations to be meaningful.

  • recommend 60-month loans over 36-month loans
  • recommend focusing on larger loans

Also, the relationship between default risk and length of credit history is not linear. The risk is high for both short or long credit history, the risk is lower with borrowers whose credit history is of moderate length.

This is a Masters Paper?  A 12th grader could have come up with the same conclusions with a lot less big words.

Here is what he concluded:
"An investor should first focus on a borrower’s loan interest rate and FICO score.  Holding all other risks factors constant, we would recommend 60-month loans over 30-month loans if default risk were a concern to the investor.  We’d also recommend focusing on larger loans, as they are less likely to default when compared to smaller loans. Finally we offer the fairly intuitive suggestions of preferring loans where the borrower makes a larger monthly income, is employed, and is older or has a longer credit history."
---
Anil Gupta
PeerCube Thoughts blog https://www.peercube.com/blog
PeerCube https://www.peercube.com

ee1x

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Re: Masters Project on "Determinants of Loan Default"
« Reply #5 on: May 23, 2013, 02:30:59 AM »
I can't respect a paper that has such terrible English:

  • extremely distracting switches between 1 or 2 spaces between sentences
  • "roughly there was" (passive voice)
  • "defaulting on unsecured loans is much more costly than defaults on secured loans" (unparallel structure)
  • "which can yield reasonably rates of interest"
  • he misspells the Scholes part of "Black-Scholes" as "Sholes", referring to one of the most important papers in all of modern finance
  • "Our main findings is that..." (come on, seriously????)

And some of the statements just reflect no thinking whatsoever...

Quote
Borrowers are primarily from California and the Northeast, but every state has at least one borrower.  This does lead to a potential selection bias towards those on the coasts and those with credit card debt, but selection bias is inevitable. 

A selection bias in what? Who is doing the "selecting" in this context? I could think of several different ways to interpret this.

In the paragraph immediately following, he goes on to state, in present tense, that "Lending Club is extremely attractive to investors" and then cites a quote from the year 2000 as a reason. As a matter of fact, most of the sources cited in the entire paper are completely irrelevant and look like they were just thrown in to make it look like there was a ton of research done.

Quote
...would reduce the probability of default on a loan by .0008%.

If this guy had any statistical credibility whatsoever, he wouldn't be trying to make an argument, even in passing, based on a number that is CLEARLY effectively zero. You don't need to be well-versed in statistics to realize how dumb it was to even include this number in the paper at all.

Ugh.

At least we can take refuge in the fact that the p2p world is still expanding rapidly, and therefore it is highly likely we will see more sound academic studies being done in the near future.
Investing since March 2012

ee1x

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Re: Masters Project on "Determinants of Loan Default"
« Reply #6 on: May 23, 2013, 02:43:11 AM »
Oh, and the icing on the cake: this dude ACTUALLY got his Master's after this atrocity of a paper, and now works as a Quantitative Analyst at Allstate.

Just... wow.
Investing since March 2012

Fred

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Re: Masters Project on "Determinants of Loan Default"
« Reply #7 on: May 23, 2013, 06:09:22 AM »
Well, we all know that people who actually make money in the financial industry never reveal their secret sauce.

ee1x

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Re: Masters Project on "Determinants of Loan Default"
« Reply #8 on: May 23, 2013, 08:38:28 AM »
Well, we all know that people who actually make money in the financial industry never reveal their secret sauce.

 ;)
Investing since March 2012

yojoakak

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Re: Masters Project on "Determinants of Loan Default"
« Reply #9 on: May 23, 2013, 11:02:36 AM »
Came for a lesson on Linear Algebra.

Went away disappointed.

New Jersey Guy

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Re: Masters Project on "Determinants of Loan Default"
« Reply #10 on: May 23, 2013, 11:20:15 AM »
Just out curiosity, I used this guys model in Interest Radar just to see what popped up.  I did not configure the RO1 or RO4, as it was not part of his model.

Credit Grade:               A
Amount Requested:     $21K to $35K
Term:                           60 Months
Loan Purpose:             Any
FICO:                           715 and Higher
Credit history:             2004 and older
Total Credit Lines:       Over 21
Home ownership:        Mortgage and own
Employment length:    minimum 5 years
Income:                       Over $4,000/mo.

TOTAL LC RESULTS:        0
FOR SALE ON FOLIO     0

His model is in a perfect world, and a perfect world doesn't exist.
Return over deposits:   66.82%
IRR:   86.54%
As of April 30, 2014

SarahV

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Re: Masters Project on "Determinants of Loan Default"
« Reply #11 on: May 23, 2013, 12:07:12 PM »
The combination of A/60 months/$21k-$35k does not exist, forget the rest of the details :)

60 months alone bumps it from A1 to A5, I believe, so adding the "large loan" bump will take it out of the A range altogether.

New Jersey Guy

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Re: Masters Project on "Determinants of Loan Default"
« Reply #12 on: May 23, 2013, 12:45:06 PM »
Sarah....Yea, yea, you're right!  I totally forgot about that!  For kicks I later added B grade.   Still, no loans came up on the LC Platform, and there were 11 listed for sale on Folio.  ALL were A5 like you said.
Return over deposits:   66.82%
IRR:   86.54%
As of April 30, 2014

AmCap

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Re: Masters Project on "Determinants of Loan Default"
« Reply #13 on: May 23, 2013, 02:07:23 PM »
God forbid y'all should ever find any of my written work online.  Oof!

AmCap

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Re: Masters Project on "Determinants of Loan Default"
« Reply #14 on: May 23, 2013, 02:09:18 PM »
The combination of A/60 months/$21k-$35k does not exist, forget the rest of the details :)

60 months alone bumps it from A1 to A5, I believe, so adding the "large loan" bump will take it out of the A range altogether.

Hahahaha I am DYING!