Hurdle models of loan default

Moffatt, P. G. (2005) Hurdle models of loan default. Journal of the Operational Research Society, 56. pp. 1063-1071. ISSN 0160-5682

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Abstract

Some models of loan default are binary, simply modelling the probability of default, while others go further and model the extent of default (eg number of outstanding payments; amount of arrears). The double-hurdle model, originally due to Cragg (Econometrica, 1971), and conventionally applied to household consumption or labour supply decisions, contains two equations, one which determines whether or not a customer is a potential defaulter (the ‘first hurdle’), and the other which determines the extent of default. In separating these two processes, the model recognizes that there exists a subset of the observed non-defaulters who would never default whatever their circumstances. A Box-Cox transformation applied to the dependent variable is a useful generalization to the model. Estimation is relatively easy using the Maximum Likelihood routine available in STATA. The model is applied to a sample of 2515 loan applicants for whom loans were approved, a sizeable proportion of whom defaulted in varying degrees. The dependent variables used are amount in arrears and number of days in arrears. The value of the hurdle approach is confirmed by finding that certain key explanatory variables have very different effects between the two equations. Most notably, the effect of loan amount is strongly positive on arrears, while being U-shaped on the probability of default. The former effect is seriously under-estimated when the first hurdle is ignored.

Item Type:	Article
Faculty \ School:	Faculty of Social Sciences Faculty of Social Sciences > School of Economics
UEA Research Groups:	Faculty of Social Sciences > Research Centres > Centre for Behavioural and Experimental Social Sciences Faculty of Social Sciences > Research Groups > Applied Econometrics And Finance Faculty of Social Sciences > Research Groups > Behavioural Economics
Depositing User:	Vishal Gautam
Date Deposited:	01 Jan 2005
Last Modified:	22 Apr 2023 01:35
URI:	https://ueaeprints.uea.ac.uk/id/eprint/16510
DOI:	10.1057/palgrave.jors.2601922

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