A Novel IBA-DE Hybrid Approach for Modeling Sovereign Credit Ratings

Abstract

Nowadays, the sovereign credit rating is not only an index of a country’s economic performance and political stability but also an overall indicator of development and growth, as well as the trust factor that is associated with the country. Due to its importance, the vast amount of available information, and the lack of a closed-form solution, prediction models based on machine learning (ML) and computation intelligence (CI) techniques are being increasingly used to complement traditional financial approaches. In this paper, we aim to introduce a novel ML-CI approach for sovereign credit rating prediction based on a differential evolution (DE) algorithm and interpolative Boolean algebra (IBA). In fact, the proposed approach is based on a pseudo-logical function in the IBA framework derived from the historical data of publicly available indicators using the DE algorithm. Such functions are easily interpreted and enable a subtle gradation among countries. It is shown that the IBA-DE approach outperforms back-propagation neural networks on the observed problem while also providing a deeper insight into each of the indicators used for prediction and its respective influence on the prediction rating on the other.

Keywords

• sovereign credit rating
• forecasting
• differential evolution
• interpolative Boolean algebra