India Credit Risk Model

Mini Project

Build India Credit Risk (default) Model using logistic

regression.

NIVEDITA DEY - PGP BABI May’19

16/03/2019
Contents

1. Project Objective ................................................................................................................................... 2

2. Assumptions .......................................................................................................................................... 3
3. Exploratory Data Analysis – Step by step approach ............................................................................. 4
3.1 Environment Set up and Data Import ........................................................................................... 4
3.1.1 Install necessary Packages and Invoke Libraries ................................................................... 4
3.1.2 Set up working Directory ...................................................................................................... 4
3.1.3 Import and Read the Dataset ................................................................................................ 4
3.2 Variable Identification................................................................................................................... 5
3.2.1 Variable Identification – Inferences ...................................................................................... 5
3.3 Missing Value Identification.......................................................................................................... 6
3.4 Variable Transformation / Feature Creation ................................................................................ 7
3.5 Univariate Analysis ........................................................................................................................ 8
3.6 Bi-Variate Analysis......................................................................................................................... 9
3.7 Outlier Identification ................................................................................................................... 10
3.8 Correlation/Multicollinearity ...................................................................................................... 11
4. Logistic regression............................................................................................................................... 12
4.1 Model Building ............................................................................................................................ 12
4.1.1 Model-1 ................................................................................................................................... 12
4.1.2 Model-2 ................................................................................................................................... 13
4.2 Performance Metrics .................................................................................................................. 15
4.3 Rank Chart ................................................................................................................................... 18
4.4 Interpretation.............................................................................................................................. 18

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 1. Project Objective

The objective of the report is to build India Credit Risk (default) model using logistic regression
framework based on the “raw-data.xlsx” in R.

Also, reflect upon the performance of the model based on the “validation_data.xlsx”.

This exploration report will consists of the following:

 Importing the dataset in R

 Understanding the structure of dataset
 Graphical exploration
 Descriptive statistics
 Logistic Regression
 Insights from the dataset

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 2. Assumptions

The following assumptions are made for the inferential statistics:

i. Observations are independent

ii. Samples are random
iii. Measurements are accurate

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3. Exploratory Data Analysis – Step by step approach

The various steps followed to analyze the case study is mentioned and explained below.

3.1 Environment Set up and Data Import

3.1.1 Install necessary Packages and Invoke Libraries

The lists of R packages used to analyze the data are listed below:

 readxl to Read xlsx data file

 dplyr to scale data
 corrplot library for correlation
 lattice for plots
 caret to calculate confusionMatrix
 ROCR to calculate auc,KS
 ineq to calculate gini
 ggplot2 for Data Visualization
 car for vif
 DataExplorer for metrics
 Data.table for rank chart

3.1.2 Set up working Directory

Setting up the working directory will help to maintain all the files related to the project at one place
in the system.

The working directory, I have setup is a local folder in the laptop.

Please refer Appendix A for Source Code.

3.1.3 Import and Read the Dataset

The given datasets are in “.xlsx format, so to import the data in R we use the “read_excel”
command.

Data in file “raw-data.xlsx” is stored in a variable called “rawTrainData”.

And data in file “validation_data.xlsx” is stored in variable called “valTestData”.

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 Please refer Appendix A for Source Code.

3.2 Variable Identification

 dim : to check dimension (#rows/columns) of a data frame

 str : Display internal structure of an R object
 head : it will show the first n rows of a data frame or matrix in R(default is 6)
 summary: It gives the 5 number summary, basically the 5 statistical values, namely the minimum
value, the first quartile, the median, the third quartile, and the maximum value of a data set
 as.factor: To convert variable to factor
 as.data.frame: To convert to data frame
 histogram: to compute histogram of the variables
 boxplot: to draw box plot which shows 5 number(mean, quartiles)
 is.na: to check if there is any missing value
 sapply: to apply is.na to all the objects parameter to each column of sub-data frame defined by
the by input parameter

3.2.1 Variable Identification – Inferences

 DIM
 rawTrainData data frame : There are 3541 rows and 52 columns
 valTestData data frame: There are 715 rows and 52 columns

 STR
 There are 52 variables in the raw an validation dataset.

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  HEAD
 rawTrainData data frame: Verifying head records

 valTestData data frame: Verifying head records

 SUMMARY
 rawTrainData and valTestData data frame: The variables, namely, WIP Turnover, Raw
material turnover shares outstanding etc should be numbers. So we will convert them to
numeric. The continuous variables have outliers and there are missing values as well
Please refer Appendix A for Source Code.

3.3 Missing Value Identification

We use ‘is na’ function to check if there are any missing values. There are missing values. Hence
we plot to get the overall status

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 rawTrainData:

ValTestData:

We replaced the missing values with the mean value for both the dataset
Please refer Appendix A for Source Code.

3.4 Variable Transformation / Feature Creation

In Summary of data we have seen that few of the variables should be numeric. So we use ‘
as.numric ‘ to convert them.

We also add a variable ‘Default’ based on the value of NetWorthNextYear

0 if NetWorthNextYear is positive,
1 if NetWorthNextYear is negative

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 The following variables were created on train dataset:
Variable Name Type Formula
PAT2Sales Profitability Profit after tax/sales
PAT2Totalassets Profitability Profit after tax/total asset
PAT2Equity Profitability Profit after tax/total equity
Liquidity Liquidity Net working Capital/total asset
Leverage Leverage Total liabilities/total equity
Totalincome2Totalassets size Total income/Total assets

Please refer Appendix A for Source Code.

3.5 Univariate Analysis

We are analyzing the all the 50 independent variable from data set ‘rawTrainData’. The ‘Networth
Next Year’ variable is the dependent variable. We have created a variable ‘default’ from ‘Networth
Next Year’.Refer to Variable Transformation section for the same. Then we perform Univariate
and Bivariate analysis.

• All the variables, except few like PE on BSE and Cumulative retained profit, are
concentrated to a particular range of values. They are either right on left skewed. Hence
there is difference in mean and median.

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 • Change in stock, Long Term Liabilities/tangible net worth, net working capital , raw
material turnover and E on BSE has negative values.
• The summary shows there is an outlier in most of the continuous variables. But the
number is very less.
• The scatter plot shows that values are not widely spread and there are outliers in most of
the variables.

Please refer Appendix A for Source Code.

3.6 Bi-Variate Analysis

We will analyze default with the other variables from data set ‘rawTrainData’.
Most of the variables do not seem to have much effect whether company will default or not
Companies who have defaulted have low PAT as % on networth.

Companies who have PE on BSE in range on 0-50 are likely to default

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 Please refer Appendix A for Source Code

3.7 Outlier Identification

There are outliers in very most of the variables. It is evident from the box plot and summary as
well. For example, hence we have removed anything above 99% and anything below 1% in
rawTrainData.

Please refer Appendix A for Source Code.

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3.8 Correlation/Multicollinearity

Based on the above plot we can many of the variables are highly co-related.

Hence, we will check the multicollinearity during model building and drop the variable is
required.

Please refer Appendix A for Source Code.

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4. Logistic regression

Logistic regression is part of the supervised learning. Logistic regression is used to describe data
and to explain the relationship between one dependent binary variable and one or more nominal,
ordinal, interval or ratio-level independent variables.
The independent variable, default, is dichotomous in nature.

We can scale the data to reduce the impact of outliers. While model building, we have checked
with scaled data as well but there was no impact on the model due to scaling. Hence, we are not
scaling the data.

4.1 Model Building

We have used rawTrainData to build the model.

4.1.1 Model-1

The initial model we will build is with all the variables and we will check the multicollinearity

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 Since there are 4 coefficients not defined because of singularities we cannot calculate vif. Hence
we remove those and create the model to check for multicollinearity

Multicollinearity: VIF for all the variables are less. Hence there is no multicollinearity.

Please refer Appendix A for Source Code.

4.1.2 Model-2

We build the final model by removing the variables with highest p value till most of the variables
are significant and AIC is also low.

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To predict the class, we find the threshold value, which comes to around 0.1, from the plot given below:

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4.2 Performance Metrics

Confusion Matrix: For Training Dataset

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 Metrics Value for Training Dataset
Accuracy 0.89
Sensitivity 0.78
Specificity 0.90
AUC 0.92
K-S 0.70
Gini 0.74

Confusion Matrix: For validation Dataset

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 Metrics Value for testing Dataset
Accuracy 0.83
Sensitivity 0.79
Specificity 0.84
AUC 0.88
K-S 0.68
Gini 0.76

Please refer Appendix A for Source Code.

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4.3 Rank Chart

Lift: For Raw data

Lift : for validation data

Please refer Appendix A for Source Code

4.4 Interpretation

Based on the performance metrics of the model on raw and validation data, we can say the model
is good and stable. As the values for AUC, Gini, K-S and lift are nearly comparable for raw and
validation data.
Based on the train metrics we can interpret that:

1. The model will catch 77% of the companies who will actually ‘Default’
2. The model will catch 90% of the companies who will actually ‘Not default’
3. Overall, accuracy is 79%
4. Out of the companies that the model predicted will ‘Default’, about 30% of them will actually
default
5. Out of the companies that the model predicted will ‘Not default’, about 95% of them will
actually Not default
6. AUC is about 80%, so it is a good classifier
7. K-S is 70% which is also good, hence the model has good power to separate between default
and not default
8. Gini is also above 70% so the model has good prediction power
9. Lift is also about 7 times

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