What is 'Behavioral Modeling'

Behavioral modeling means using available and relevant consumer and business spending data to estimate future behavior. Behavioral modeling is used by financial institutions to estimate the risk associated with providing funds to an individual or business but is also used in marketing, advertising and sales forecasting. A new area of economics, called behavioral economics, also relies heavily on behavioral modeling to predict behaviors of agents that fall outside of what would be considered entirely fact-based or rational behavior.

BREAKING DOWN 'Behavioral Modeling'

Financial institutions, such as banks and credit card companies, use behavioral modeling to estimate how individuals are likely to use their services. For example, a credit card company will examine the types of businesses that a card is normally used at, the location of stores, and the frequency and amount of each purchase to estimate both future purchase behavior and whether a cardholder is likely to run into repayment problems.

Example of Behavioral Modeling

For example, a credit card company may notice that a cardholder has shifted from making purchases at discount stores to high-end stores over the last six months. By itself, this may indicate that the cardholder has seen an increase in income, or could mean that the cardholder is spending more than he or she can afford. To narrow down the options and create a more accurate risk profile, the card company will also look at other data points, such as whether the cardholder is only paying the minimum payment or if the cardholder has made late payments. Late payments may be an indicator that the cardholder is at a greater risk of insolvency.

Behavioral modeling is also used by retailers to make estimates about consumer purchases. A retailer could, for example, examine the types of products that a consumer purchases in-store or online and then estimate the likelihood that the consumer will purchase a new product based on how similar it is to his/her previous purchases. This is especially useful to retailers who provide customer loyalty programs, which allow them to track individual spending patterns with more granularity. For example, if a store determines that consumers that purchase shampoo will also purchase soap if provided a coupon, the store may provide a coupon for soap at a point-of-sale terminal to a consumer who only purchases shampoo.

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