Dormancy risk and expected profits of consumer loans

A bank that lends money to a household faces two types of risk, Frequently mentioned is the risk of default. Seldom referred to is the risk of an early redemption of the loan - leading to dormancy. In this paper, we model the transition of consumer loans from an active to a dormant state. To this end, we use data on 4786 individuals who were granted credit by a Swedish lending institution between September 1993 and August 1995 and estimate a semi-parametric duration model. We analyze the factors that determine the time to maturity on consumer loans and investigate the ability of the model to match the maturities observed in the data. Moreover, we derive the distribution of conditional expected durations of loans and show how a loan application can be evaluated by calculating its expected profit. (C) 2001 Elsevier Science B,V. All rights reserved.