Introduction

This report regression five factors in 1990 and 2010, in order to create two new credit scoring
models, then, compare them with Altmans model, it can find out some weakness of new
models. Use our model to get predict values, compare them with actual values, and then
divided them into five groups based on the difference between predict values and actual
values. Eventually, this report research some other unsystematic factors and systematic factors
which are have influence on credit scoring model.
Regression and create models in 1990 and 2010
It is easy to create the two credit scoring models in 1990 and 2010 based on the coefficients.
In 1990, Z = 2.244+ (-0.424)*X1+1.033*X2+1.692*X3+0.005*X4+ (-0.113)*X5;
In 2010, Z = 2.186+ (-0.365)*X1+0.476*X2+1.726*X3+0.003*X4+ (-0.096)*X5;
According to Altman, Z = 1.2*X1+1.4*X2+3.3*X3+0.6*X4+1.0*X5.
Similarity of three models
All independent variables in the three model are same, X 1, X2, X3, X4 and X5 stand for
working capital/assets, retained earnings/assets, EBIT/assets, book equity/long term debt, and
sales/assets respectively. The order of importance of those five elements in three models are
same, the order from most significant to least significant are X 3, X2, X1, X5, and X4
respectively.
Difference between credit model in 1990 and 2010 and potential reasons
Pay attention to the coefficient of credit scoring model in 1990 and 2010, there are very
similar, both working capital/assets and sales/assets have negative relationship with Z score,
and the EBIT/assets is the most important elements for Z score on the two models, while the
EBIT/assets have more influence on 2010, because the coefficient in 2010 is 1.726 while
1.692 in 1990. The maximum differentiation among coefficient is retained earnings/assets, the
number decreased from 1.033 in 1990 to 0.476 in 2010, which means retained earnings/assets
influence on Z-score decreased dramatically. These sample in 1990 and 2010 are different
company with different industry; the sample size in 2010 (1325) are larger than 1990 (988);
the company could change over twenty years, all those can be used to explain the difference
of coefficients between 1990 and 2010.
Difference between our models and Altmans model and potential reasons
Compared to Altmans model, coefficients of two model in 1990 and 2010 are totally different
with his model. Regard to working capital/assets and sales/assets, it is obviously that the
coefficients of the two factors are negative value in our established model while they are
positive value in Altmans credit scoring model. In other words, working capital/assets and
sales/assets have negative relationship with Z-score in 1990, which are -0.424 and -0.113
respectively; they are also negative related to Z-score in 2010, which are -0.365 and -0.096
respectively; while they are positive related to z-score according to Altmans model, which
are 1.2 and 1.0 respectively. Meanwhile, credit scoring model in 1990 and 2010 have
intercept, while Altmans model ignores intercept under normal circumstance. Altman is the

most common acceptable model in modern society, therefore, the difference between our
models and Altmans model may cause by weakness of our models. The sample size are too
small to predict correctly, which are only approximately 1000; these industries in collected
data are not exactly match with Altmans; the time period in each model are only one year, it
is too short to be trusted. All those can provide reasonable explanations about these
difference.
Five group base on difference between actual values and predict values
This report rank the difference between actual values and predict values from smallest to
largest, and divided them into five group, the sample size of each group is 265. Based on the
data, it is easy to conclude that the average difference of first and fifth group are large, it
means that the predict value of first and fifth group deviate from the actual value seriously.
The smallest average difference is the third group, which means predict value of third group
is most closely to actual value. With respect to S&P rating numerical value, it increase from
first group (6.42) to fifth group (13.67). As for average beta, the group 3 are the most
significant one for each factor.

Research on other factors affect credit scoring model

Friedman (1991) first proposed Multivariate adaptive regression splines (MARS), which is a
nonlinear and non-parametric regression methodology. According to Lee, T. S., & Chen, I. F.
(2005), they list 18 variables, including gender, age, education level, occupation, purpose of
buying property and so on. Based on MARS, the monthly installment is the most significant
factor, the relative importance value of number of guarantor is close to 90%. Loan type and
loan amount are around 63%, while marital status is not so important factor which is only
28%. Steenackers, A., & Goovaerts, M. J. (1989) also list some characteristics of applicant,
and 11 out of 19 could be as variables included in the credit scoring model. In West, D (2000)
opinion, it describe 24 variables including credit history, account balance, loan purpose,
personal information etc. For German data, account longevity is the most significant factor,
credit history, employment classification and checking account status are also significant
factor for credit scoring model. However, this report also point out that the data in German
cannot be used in American and Australia. Orgler, Y. E. (1970) analysis some factors for
commercial purpose. Criticized last examination and past-due are the most significant factors,
the coefficients are -0.4533 and -0.3966 respectively. It can be recognized as credit history
has most significant influence on credit scoring model. At the same time, net profit, secured
and audit also have important influence on this model.

To be concluded, those report mainly discussed the unsystematic factors, and it can be easy
divided into two parts, commercial loans and personal loans. For both commercial loans and
personal loans, credit history, duration of loans, and purpose of loans are significant factors.
For personal, the factors need to be considered are relatively more, including monthly
installment, loan amount, loan type, employment, account longevity, guarantor and so on.
Those factors are negative related to credit default risk exception loan amount. As for
commercial loan, the loan amount seems to be less important factors, because the amount of
commercial loans are usually large. In addition, commercial loans are relatively customized, it
is hardly to make some rules and regulations, and accordance with these rules strictly. In this
report, net profit, secured and audit can regarded as important factors for credit scoring
model.
On the other hand, changing in political, economic policies (like tax and import restriction)
are important systematic factors, but difficult to examine. There are five macroeconomic
factors could be discussed. According to Castro, V (2010), decrease in real GDP (1%) leads to
an immediate increase in the risk of credit (0.035%); stock price is also negative related to
credit risk; increase in long-term interest rate (1%) results to increase in risk (0.06%); credit
expands also leads to increase in risk, while this effect may not immediately; real effective
exchange rate has positive correlation with credit risk, because a real appreciation of the local
currency illustrates that goods and services are relatively more expensive.

The weakness of Altmans model

Although Altman is the most popular method for linear discriminant
models, this model still have some weakness. First of all, the Altmans Z
score model allocated fixed-weights to each of factors, which is
unreasonable, because variables and weights unlikely to be constant over
longer periods of time. In the second place, Altmans model is formulated
for operating industry, and it will not suited for all industries. Furthermore,

the data used for create model are based on financial analysis. It may
leads to inaccurate prediction because it ignores non-financial factors and
it may use some false data which provided by unfaithful company
(Mandru, L. 2010).

According to the above table, the predicted 1990 is the z-score based on my
model in 1990, while the Z-score 1990 is according to Altmans model, same
as 2010. According to Altman, if z-score less than 1.81, the loan with very low
quality and high default risk; if z-score between 1.81 and 2.99, the loan is
hybrid; if z-score large than 2.99, the loan with very high quality and low
default risk. The type of loan based on my model and Altmans model in 1990
and 2010 are illustrated below.
The following table is for 1990:
Firm ID(1990)
S&P rating
My model
Altmans model
1004
BBB
Hybrid
High quality
1034
BB
Hybrid
Hybrid
1045
AHybrid
Low quality
1161
B+
Hybrid
High quality
1245
B+
Low quality
High quality
1311
CCC+
Low quality
Low quality
The following table is for 2010:
Firm ID
S&P rating
My model
Altmans model
1004
BB
Hybrid
High quality
1045
BHybrid
Low quality
1161
B+
Low quality
Low quality
1224
BBB
Hybrid
Hybrid
1388
BHybrid
Low quality
According the above table, the same firm in same year can be divided into
different type of loan based on different model (my model and Altmans
model). Focus on 1990, there is only one out of six firm remain hybrid loan
based on different model, the other five firms are belong to different type of

loan as the model different (.