Credit Migration in Residential Mortgages: Fico Drift as a Prelude to Loan Performance

Abstract

This article represents an extension of the expansive credit risk and credit migration literature, prominent in option pricing risk analysis of corporate bond and securities investment, to an analysis of the drift of consumer credit scores over the first 3 years of a mortgage loan. A rich data set of residential mortgages is used in the development of models to predict credit score migration and then to illustrate the potential of credit score transition as a precursor of default and prepayment. The results are especially useful for servicing agents and investors in a fashion similar to credit ratings on commercial paper.