Transition matrix models of consumer credit ratings

Although the corporate credit risk literature has many studies modelling the change in the credit risk of corporate bonds over time, there is far less analysis of the credit risk for portfolios of consumer loans. However behavioural scores, which are commonly calculated on a monthly basis by most consumer lenders are the analogues of ratings in corporate credit risk. Motivated by studies in corporate credit risk, we develop a Markov chain model based on behavioural scores to establish the credit risk of portfolios of consumer loans. Although such models have been used by lenders to develop models for the Basel Accord, there is no published literature on them. The model we suggest differs in many respects from the corporate credit ones based on Markov chains ? such as the need for a second order Markov chain, the inclusion of economic variables and the age of the loan. The model is applied using data on a credit card portfolio from a major UK bank.