Example: Modeling and Valuation of Leasing Contracts
A main challenge for companies that offer leasing contracts is to exactly determine the so-called "residual value" of a vehicle. Hereby, the "residual value" defines the value of a vehicle at the end of the contract. For the German market this value can be retrieved only at the very end of each contract based on the so-called "Schwacke"-list. For other markets this achievement is even more complex. Hence, several interesting questions arise:
- How does the value of the vehicle evolve over the contract period?
- Which characteristics of the contract or vehicle features are most relevant to determine the residual value?
- Which value of the leasing contract should be depicted in the books?
- Which amount has to be retained in order to cover risks?
To answer these questions, we have derived a model for leasing contracts. Using the model, predictions of the "residual value" are made depending on the remaining term. Furthermore, accuracies of these predictions are provided and even increase with the contract approaching the end.
In comparison to the benchmark, our model achieves lower mean squared deviations from the actual "residual value". With other words, our model yields more reliable prognoses at the beginning of the contract as well as during the contract period. Hence, it represents a significant improvement of the standard approach.