Soft-hard data fusion using uncertainty balance principle –corporate credit risk in commercial banking

Abstract

This study introduces Uncertainty Balance Principle (UBP) as a new concept/method for incorporating additional soft data into probabilistic credit risk assessment models. It shows that soft banking data, used for credit risk assessment, can be expressed and decomposed using UBP and thus enabling more uncertainty to be handled with a precise mathematical methodology. The results show that this approach has relevance to credit risk assessment models in the sense that it proved its usefulness for the purpose of soft-hard data fusion, it modified Probability of Default with soft data modeled using possibilistic (fuzzy) distributions and fused with hard probabilistic data via UBP and it obtained better classification prediction results on the overall sample. This was demonstrated on a simple example of one soft variable, two experts and a small sample and thus this is an approach/method that requires further research, enhancements and rigorous statistical testing for the application to a complete scoring and/or rating system.