Comments on: Lending Club’s Interesting Definition of Risk http://www.lazymanandmoney.com/lending-clubs-interesting-definition-of-risk/ Saving, Earning, and Investing Money Sat, 21 Nov 2009 00:22:17 -0800 http://wordpress.org/?v=2.8.5 hourly 1 By: Mahesh http://www.lazymanandmoney.com/lending-clubs-interesting-definition-of-risk/comment-page-1/#comment-145321 Mahesh Fri, 14 Aug 2009 12:30:05 +0000 http://www.lazymanandmoney.com/?p=1774#comment-145321 Mike, what is the formula you used to get the value of each outcome in your monte carlo simulation? Mike, what is the formula you used to get the value of each outcome in your monte carlo simulation?

]]> By: Mike http://www.lazymanandmoney.com/lending-clubs-interesting-definition-of-risk/comment-page-1/#comment-127603 Mike Fri, 06 Mar 2009 14:10:42 +0000 http://www.lazymanandmoney.com/?p=1774#comment-127603 I was having a hard time getting a handle on default risk, particularly for small value portfolios, like the ones you are discussing. The trouble is that historical default rates don't really apply until you have a statistically significant number of loans. I'm not sure if you've seen my <a href="http://www.richerbytheday.com/2008/11/p2p-lending-default-considerations-part-2.html" rel="nofollow">P2P Default Simulation results</a> but they helped me to gain a better understanding of the risks. Basically, my analysis showed that when you only have a few loans, since any default would result in a large percentage of your portfolio being lost, you're better off investing in lower grade loans. As you get more and more loans, the diversification tends to moderate the higher risk of the lower grade loans, again making them preferred. Obviously the defaults at Lending Club won't necessarily follow the historical default rates, but the results were still surprising to me. I was having a hard time getting a handle on default risk, particularly for small value portfolios, like the ones you are discussing. The trouble is that historical default rates don’t really apply until you have a statistically significant number of loans. I’m not sure if you’ve seen my P2P Default Simulation results but they helped me to gain a better understanding of the risks. Basically, my analysis showed that when you only have a few loans, since any default would result in a large percentage of your portfolio being lost, you’re better off investing in lower grade loans. As you get more and more loans, the diversification tends to moderate the higher risk of the lower grade loans, again making them preferred. Obviously the defaults at Lending Club won’t necessarily follow the historical default rates, but the results were still surprising to me.

]]> By: Tom http://www.lazymanandmoney.com/lending-clubs-interesting-definition-of-risk/comment-page-1/#comment-127444 Tom Wed, 04 Mar 2009 19:16:33 +0000 http://www.lazymanandmoney.com/?p=1774#comment-127444 Very interesting - I had not noticed this. Very interesting – I had not noticed this.

]]> By: Jeremy http://www.lazymanandmoney.com/lending-clubs-interesting-definition-of-risk/comment-page-1/#comment-127440 Jeremy Wed, 04 Mar 2009 17:41:50 +0000 http://www.lazymanandmoney.com/?p=1774#comment-127440 Well, the risk calculation should take into account both the number of loans in the portfolio and the quality of the borrower. Obviously, if you have a portfolio of just 1 E loan compared to a portfolio with 3 E loans, while both may carry the same type of risk due to credit quality, the fact that you have it spread out across 3 loans instead of one should lower the risk. You have a better chance of that one single loan defaulting compared to all three of your other loans defaulting. That being said, a 1 E loan portfolio should have higher risk when compared to a 1 B loan portfolio instead of just showing the risk value as 1/1 since it should take into account the default rates based on credit quality. I'm no math wizard, but I bet it wouldn't be terribly difficult to change the calculation to include a combination of the number of loans and credit quality. Well, the risk calculation should take into account both the number of loans in the portfolio and the quality of the borrower. Obviously, if you have a portfolio of just 1 E loan compared to a portfolio with 3 E loans, while both may carry the same type of risk due to credit quality, the fact that you have it spread out across 3 loans instead of one should lower the risk. You have a better chance of that one single loan defaulting compared to all three of your other loans defaulting.

That being said, a 1 E loan portfolio should have higher risk when compared to a 1 B loan portfolio instead of just showing the risk value as 1/1 since it should take into account the default rates based on credit quality.

I’m no math wizard, but I bet it wouldn’t be terribly difficult to change the calculation to include a combination of the number of loans and credit quality.

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