Journal of Productivity Analysis

, Volume 21, Issue 2, pp 153–165

Using DEA and Worst Practice DEA in Credit Risk Evaluation

  • Joseph C. Paradi
  • Mette Asmild
  • Paul C. Simak
Article

Abstract

The purpose of this paper is to introduce the concept of worst practice DEA, which aims at identifying worst performers by placing them on the frontier. This is particularly relevant for our application to credit risk evaluation, but this also has general relevance since the worst performers are where the largest improvement potential can be found. The paper also proposes to use a layering technique instead of the traditional cut-off point approach, since this enables incorporation of risk attitudes and risk-based pricing. Finally, it is shown how the use of a combination of normal and worst practice DEA models enable detection of self-identifiers. The results of the empirical application on credit risk evaluation validate the method. The best combination of layered normal and worst practice DEA models yields an impressive 100% bankruptcy and 78% non-bankruptcy prediction accuracy in the calibration data set, and equally convincing 100% and 67% out-of-sample classification accuracies.

data envelopment analysis credit risk worst practice DEA layering or peeling technique 

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Copyright information

© Kluwer Academic Publishers 2004

Authors and Affiliations

  • Joseph C. Paradi
    • 1
  • Mette Asmild
    • 2
  • Paul C. Simak
    • 3
  1. 1.Department of Chemical Engineering and Applied ChemistryCMTE, University of TorontoTorontoCanada
  2. 2.CMTE, University of TorontoCanada
  3. 3.McKinsey & CompanyCanada

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