Loss given default models incorporating macroeconomic variables for credit cards

Based onUKdata formajor retail credit cards,we build severalmodels of Loss GivenDefault based on account level data, including Tobit, a decision tree model, a Beta and fractional logit transformation. We find that Ordinary Least Squares models with macroeconomic variables perform best for forecasting Loss Given Default at the account and portfolio levels on independent hold-out data sets. The inclusion of macroeconomic conditions in themodel is important, since it provides a means tomodel Loss Given Default in downturn conditions, as required by Basel II, and enables stress testing. We find that bank interest rates and the unemployment level significantly affect LGD. © 2011 International Institute of Forecasters. Published by Elsevier B.V. All rights reserved.