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Valuing Revolving Credit Card Loans with Repayment and Default Risk

Article Quant Q&A · Author: Attack68
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Summary

The document frames a quantitative valuation problem for an individual credit card balance or flexible loan, and asks how the approach would change for a pool. The proposed contract features include a required monthly minimum payment, interest accrual below the minimum repayment rate, the option to repay the full balance at any time, possible arrears, and eventual default with loss given default.

No valuation model, calculation, or cited research is supplied in the document, so it does not establish a generally accepted method. Its useful contribution is identifying the cash flow and credit risk features a model would need to represent: changing balances, optional prepayment, delinquency, default timing, and recoveries. Extending the problem to a pool would also require describing the distribution and dependence of borrower behavior, but the post leaves those choices open.

Key ideas

  • A revolving loan valuation must account for interest accrual and required minimum payments.
  • Borrowers may repay more than the minimum or clear the balance early, changing future cash flows.
  • Arrears and default risk affect expected payments, while loss given default determines recoveries.
  • A pool valuation must represent differences and potential dependence across borrowers, though no specific method is given.

Tags

Fixed incomeRisk managementStatistics
Full text
# Quant valuation of a credit card debt (or flexible loan)


# Quant valuation of a credit card debt (or flexible loan)












What would you say is the generally accepted quantitative method of valuing an individual credit card, or flexible loan? Is the method very changeable if that were a pool of such loans?

Suppose the characteristics of each loan were that they:

- Repaid a minimum amount of the loan balance each month, say 5%.

- Applied interest at some rate less than 5% per month, i.e. so balance always declines.

- Allowed flexible repayment upto the entire balance in any month.

- Might not repay (i.e. enter loan arrears)

- Officially default after being in arrears, and need to be recovered with some LGD parameter.

If anyone has academic paper links to this also appreciated.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.