A 2-Factor Model for Inclusion of Voluntary Termination Risk in Automotive Retail Loan Portfolios
- 1 Riskcare Ltd., London, UK
- 2 Riskcare Ltd., London, UK
- 3 Santander Consumer Finance UK, Redhill, UK
- 4 Santander Consumer Finance UK, Redhill, UK
- 5 Santander Consumer Finance UK, Redhill, UK
Abstract
Under the UK Consumer Act 1974, obligors of Hire Purchase and Conditional Sale contracts are allowed to perform a Voluntary Termination (VT) once certain conditions are met. Upon such an event, lenders recover the underlying assets but are potentially liable to losses upon liquidation of the assets. This poses a challenge from a risk modelling perspective, as these financial products exhibit Credit (default) risk as well as VT risk, and these two events are mutually exclusive. In this paper, we propose a modelling framework to account for Credit/Default and VT risk for Retail portfolios, designed as a 2-factor Monte Carlo simulation of loan-level termination events. The paper concludes with numerical and backtesting results from a real-life implementation of such framework in the context of an automotive loan portfolio.
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