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Title: The impact of adverse selection and the Basel Accords in different credit pricing decisions
Author: Huang, Bo
Awarding Body: University of Southampton
Current Institution: University of Southampton
Date of Award: 2012
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In the last few years, variable pricing has attracted more and more attention in consumer lending industry. In the credit card market, there is a trend that traditional pricing strategy (fixed rate pricing) is gradually being replaced by variable pricing. The objective of this thesis is to investigate how adverse election and external influences (the Basel Accords or other banking regulations) could affect lender's profitability and pricing decisions under different pricing strategies. This thesis consists of three aspects: 1) We briefly outline why and how modelling the choice of credit card by a borrower as an auction process means that the winner's curse can lead to adverse selection. We show that the relationships between the actual default risk of a borrower and the lender's perceived view of this risk are very simple ones, whatever the distribution of errors the lender makes. By building a simple model of the profit a lender makes from a loan, we are able to examine what the effect of these errors could have on the lender's expected and actual profit. 2) We look at how the regulatory capital requirements in different versions of the Basel Accords (Basel 1, Basel 2 and Basel 3) affect acceptation and pricing decisions under three distinct pricing strategies: fixed rate pricing, two rates pricing and variable rates pricing. We implement this both in the case where a lender has an agreed cost of equity for each unit of equity needed to cover the regulatory capital requirements and where a lender decides in advance how much of its equity capital can be set aside to cover the requirements of its loan portfolio. 3) We explain how two special problems (lending quota and lending floor) in credit lending affect acceptation decision of a lender. Our simple consumer lending process is found to be similar to the classical marriage/secretary problem. We thus use Markov Decision Process (MDP) model to investigate the form of optimal policy under these two limited lending problems.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available