Bayesian credit ratings: A random forest alternative approach

ABSTRACT

Cerciello and Giudici (2014) proposed a Bayesian approach to improve the ordinal variable selection in credit rating assessment. However, no comparison has been made with other methods and the predictive power was not tested. This study proposes an integrated framework of random forest (RF)-based methods and Bayesian model averaging (BMA) to validate and investigate the ordinal variable importance in evaluating credit risk and predicting default in greater depth. The proposed approach was superior to the Cerciello and Giudici method in terms of predictive accuracy and interpretability when applied to a European credit risk database.

KEYWORDS:

• Bayesian model averaging
• credit risk
• default
• random forests
• variable selection

MATHEMATICS SUBJECT CLASSIFICATION:

• 62H30