Week4 LogisticRegression-LDA PDF

+
Week 4 – Predicting Loan Repayment and

Customer Churn with Logistic Regression and
LDA IEOR 242 – Applications in Data Analysis
Spring 2020 – George Ng IEOR 242, Spring 2020 - Week 4
+ 2
Week 3 Recap
n If dependent variable is continuous à regression such as linear
regression
n If dependent variable is binary (i.e. yes/no) à classification such as

logistic regression
n Business objectives will inform which performance measures are most

relevant
n Many statistical measures to assess performance

n Each related to business performance but not perfect match
n Often very difficult to clearly translate objective in to a tractable optimization
problem à General model quality correlated with business objectives…
n Many different modelling approaches (and we’ll discuss many more) –

each with pros and cons, work best under certain conditions
IEOR 242, Spring 2020 - Week 4

+ 3
Annoucements
n Final Project Groups – Need to Finalize ASAP
n Project topic requires review from Instructor or GSI

– one pager due March 9

+ 4
Today’s Agenda
n Guest Lecture on Risk Modelling for Cyber Perils
n Predicting “Churn”
n ROC Analysis
n Linear Discriminant Analysis

+ 5
Customer Retention/Churn in Telecom

Companies
n US telecom market is pretty much saturated
n It is a lot harder to acquire a new customer than it

is to retain an existing customer
n Cost of acquiring a new customer is typically five

times the cost of retaining a customer

+ 6
Churn Rates of the Top Four Carriers
Q3 2015 2015
Carrier Monthly Churn Annualized Churn
Verizon 1.21% 13.6%
AT&T 1.33% 14.8%
Sprint Nextel 2.76% 28.5%
T-Mobile 2.41% 25.4%
Source: FierceWireless

+ 7
Customer Retention
n Call Comcast at end of contract and request a

discount for re-upping
n Often they’ll offer a discount instantly! (such as a

$100 Visa gift card!)

+ 8
Price Reduction Decision Tree

n The Marketing division has determined that a 20% price reduction halves
the risk of churn
n If the customer churns, the company makes $0 from this customer in the future
n If the customer does not churn, the company makes $1000 (under no price
reduction) or $800 (if they give the price reduction)
Churn $0
p/2 Elprofit I 0
Reduce Price
No Churn 80011 E
1- p/2 $800
Don’t Reduce Price
Churn $0
p Edprofit p 0
No Churn
1- p
100011
p
$1000
+ 9
Identifying High-Risk Customers

n A customer is a high churn-risk if we expect to make money from
a price reduction (corresponds to a high probability of churn)
n A customer is a low churn-risk if we expect to lose money from a

price reduction (corresponds to a low probability of churn)
n From the decision tree, our expected profit with a price reduction
is 800 x ( 1 - p/2 ) and our expected profit with no price reduction
is 1000 x ( 1 – p ) 800 1
I 100011
p
业
n Using arithmetic, the break-even point is p = 0.333
n Customers with churn probability above 0.333 are dubbed
high churn-risk
n Customers with churn probability below 0.333 are dubbed low
churn-risk
n We will only offer price reductions to high churn-risk customers

+ 10
Churn, continued
n More broadly, this is about Customer

Relationship Management (CRM)
n Approaches to limit churn

n Special offers, etc.
n Our dataset:
nA telecom working with Watson Analytics
n Data on whether customers churn in a given year

+
Customer Retention Data
IEOR 242, Spring 2020 - Week 4 11

+ 12
n Dependent variable: Whether the customer

left after their contract (1 or 0)
n Independent variables:
n Monthly charges ($)
n Is the customer a senior citizen? (1 or 0)
n Payment method for account (electronic check,
mailed check, bank transfer, credit card)
n Internet service (DSL, Fiber, or None)
n Months as a customer
n Contract type (month-to-month, 1-year, or 2-year)

+ 13

p = # of independent variables (p=6); n = # of observations (n=7032)
Churn MonthlyCharges SeniorCitizen PaymentMethod InternetService tenure Contract
1 0 29.85 0 Electronic check DSL 1 Month-to-month
2 0 56.95 0 Mailed check DSL 34 One year
3 1 53.85 0 Mailed check DSL 2 Month-to-month
4 0 42.30 0 Bank transfer DSL 45 One year
5 1 70.70 0 Electronic check Fiber optic 2 Month-to-month
7 0 89.10 0 Credit card Fiber optic 22 Month-to-month
8 0 29.75 0 Mailed check DSL 10 Month-to-month
10 0 56.15 0 Bank transfer DSL 62 One year
n=7032 11
12
0
0
49.95
18.95
0
0
Mailed check
Credit card
DSL
No
13 Month-to-month
16 Two year
13 0 100.35 0 Credit card Fiber optic 58 One year
14 1 103.70 0 Bank transfer Fiber optic 49 Month-to-month
16 0 113.25 0 Credit card Fiber optic 69 Two year
... ... ... ... ... ... ... ...
7028 0 84.80 0 Mailed check DSL 24 One year
7029 0 103.20 0 Credit card Fiber optic 72 One year
7030 0 29.60 0 Electronic check DSL 11 Month-to-month
7031 1 74.40 1 Mailed check Fiber optic 4 Month-to-month
7032 0 105.65 0 Bank transfer Fiber optic 66 Two year

+ 14
Training and Testing Set (Random Split)
Churn MonthlyCharges ... Contract 70% Training Set (n=4,922)

1 0 29.85 ... Month-to-month
2 0 56.95 ... One year Churn MonthlyCharges ... Contract
3 1 53.85 ... Month-to-month 1 0 29.85 ... Month-to-month
4 0 42.30 ... One year 2 0 56.95 ... One year
10 0 56.15 ... One year 10 0 56.15 ... One year
12 0 18.95 ... Two year 13 0 100.35 ... One year
13 0 100.35 ... One year ... ... ... ... ...
... ... ... ... ... 7031 1 74.40 ... Month-to-month
7031 1 74.40 ... Month-to-month
7032 0 105.65 ... Two year 30% Testing Set (n=2,110)
Churn MonthlyCharges ... Contract
Full Dataset (n=7,032) 4 0 42.30 ... One year
9 1 104.80 ... Month-to-month
12 0 18.95 ... Two year
... ... ... ... ...
7032 0 105.65 ... Two year

+ 15
Logistic Regression for Churn

Probability Prediction
n The dependent variable is Bernoulli random
variable (think success or failure): Y = 0 or 1
n Y = 1 if “success” – customer churns
n Y = 0 if “failure” – customer does not churn
n How do we deal with variables like

PaymentMethod and InternetService?
n We will walk through training this model in R

during the discussion section

+ 16
Logistic Regression Output

Coefficients:
Estimate Std. Error z value Pr(>|z|)
(Intercept) -0.505894 0.208913 -2.422 0.015454 *
MonthlyCharges 0.001934 0.003601 0.537 0.591318
SeniorCitizen 0.337874 0.097374 3.470 0.000521 ***
PaymentMethodCredit card -0.217340 0.135296 -1.606 0.108186
PaymentMethodElectronic check 0.313616 0.110324 2.843 0.004474 **
PaymentMethodMailed check -0.106306 0.131246 -0.810 0.417954
InternetServiceFiber optic 0.979730 0.153601 6.378 1.79e-10 ***
InternetServiceNo -0.798349 0.178696 -4.468 7.91e-06 ***
tenure -0.032528 0.002569 -12.660 < 2e-16 ***
ContractOne year -0.701521 0.125113 -5.607 2.06e-08 ***
ContractTwo year -1.616726 0.213029 -7.589 3.22e-14 ***
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
(Dispersion parameter for binomial family taken to be 1)

glm.fit <- glm(Churn ~ MonthlyCharges + SeniorCitizen + …, data = churnData.train, family = ‘binomial’)
Null deviance: 5699.5 on 4921 degrees of freedom
summary(glm.fit)
Residual deviance: 4208.7 on 4911 degrees of freedom
AIC: 4230.7
Number of Fisher Scoring iterations: 6

+ 17
Logistic Regression Output after

removing Monthly Charges
Coefficients:
(Intercept) -0.414419 0.120689 -3.434 0.000595 ***
SeniorCitizen 0.336613 0.097339 3.458 0.000544 ***
PaymentMethodCredit card -0.217518 0.135288 -1.608 0.107875
PaymentMethodElectronic check 0.314519 0.110313 2.851 0.004356 **
PaymentMethodMailed check -0.107838 0.131221 -0.822 0.411186
InternetServiceFiber optic 1.046986 0.089274 11.728 < 2e-16 ***
tenure -0.032076 0.002425 -13.227 < 2e-16 ***
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Null
glm.fit <- deviance:
glm(Churn 5699.5 on+ PaymentMethodCredit
~ SeniorCitizen 4921 degrees of freedom
+ …, data = churnData.train, family = ‘binomia
summary(glm.fit)
AIC: 4229

+ 18
Logistic Regression Output after also

removing PaymentMethodCredit card
Coefficients:
(Intercept) -0.520885 0.083921 -6.207 5.40e-10 ***
SeniorCitizen 0.338071 0.097318 3.474 0.000513 ***
ElectronicCheck 0.419207 0.080747 5.192 2.08e-07 ***
InternetServiceFiber optic 1.048240 0.088697 11.818 < 2e-16 ***
tenure -0.032051 0.002367 -13.542 < 2e-16 ***
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Null deviance: 5699.5 on 4921 degrees of freedom

AIC:<-4227.6
glm.fit glm(Churn ~ SeniorCitizen + ElectronicCheck + …, data = churnData.train, family = ‘binomial’)
summary(glm.fit)

+ 19
Price Reduction Decision Tree

n The Marketing division has determined that a 20% price reduction halves
the risk of churn
n If the customer churns, the company makes $0 from this customer in the future
n If the customer does not churn, the company makes $1000 (under no price
reduction) or $800 (if they give the price reduction)
Churn $0
p/2
Reduce Price
No Churn
1- p/2 $800
Don’t Reduce Price
Churn $0
p
No Churn
1- p
$1000
+ 20
Using the Logistic Regression

Model
n Recall that the break-even point is p = 0.333
n Customers with churn probability above 0.333 are
dubbed high churn-risk
n Customers with churn probability below 0.333 are
dubbed low churn-risk
n Let’s use the logistic regression model to identify

high churn-risk and low churn-risk customers in
the test set

+ 21
Identifying Churn-Risk Customers in

the Test Set
Churn-Risk: p = Pr(Yi = 1) > 0.333
Churn SeniorCitizen ... Contract Pr(Yi = 1) Churn-Risk
4 0 0 ... One year 0.066 0
9 1 0 ... Month-to-month 0.512 1
12 0 0 ... Two year 0.029 0
15 0 0 ... Month-to-month 0.536 1
28 1 0 ... Month-to-month 0.467 1
29 0 0 ... Two year 0.012 0
30 1 0 ... Month-to-month 0.256 0
37 1 0 ... Month-to-month 0.687 1
38 0 0 ... Month-to-month 0.279 0
39 1 0 ... Month-to-month 0.464 1
48 1 0 ... Month-to-month 0.707 1
49 0 0 ... Two year 0.022 0
52 1 0 ... Month-to-month 0.512 1
... ... ... ... ... ... ...
7017 0 0 ... Month-to-month 0.281 0
7021 0 1 ... One year 0.067 0
7025 0 0 ... Month-to-month 0.480 1
7030 0 0 ... Month-to-month 0.388 1
7032 0 0 ... Two year 0.039 0

+ 22
Confusion Matrix
1238 + 418
Accuracy = = 0.785
1238 + 311 + 143 + 418
T rue P ositives 418

T rue P ositive Rate (T P R) = = = 0.745
All P ositives 418 + 143
F alse P ositives 311

F alse P ositive Rate (F P R) = = = 0.201
All N egatives 1238 + 311
Model
Low Churn-Risk High Churn-Risk
Pr(Yi = 1) < 0.333 Pr(Yi = 1) > 0.333
Reality No Churn (Yi = 0) 1,238 311
Churn (Yi = 1) 143 418

+ 23
Many Customer Retention

Inducements
n The Marketing Division has many different customer
retention inducements available to them:
n Smaller/larger discounts
n Free services (with limited time offer)
n Options focused only on certain customers (e.g. fiber optic
customers, or senior citizens, or …)
n Each option would require its own decision tree, break-

even threshold calculation, and confusion matrix
n Let us now see how we can assess how well the model
performs across all break-even thresholds

+
Receiver Operating
Characteristic (ROC) Analysis

+ 25
Receiver Operating Characteristic

(ROC) Analysis
n The ROC curve captures the trade-off between
false positive rates and true positive rates as the
break-even threshold used to make the confusion
matrix is varied
n Some history: The ROC curve was first used in

World War II for the analysis of radar signals for
aircraft. In 1950s ROC curves were used in signal
detection more broadly

+ 26
Logistic Model with break-even

threshold p = 0.333
Model
Pr(Y = 1) < 0.333 Pr(Y = 1) > 0.333
Reality No Churn (Y = 0) 1,238 311
Churn (Y = 1) 143 418
1.00
TPR = 0.745
True Positive Rate

0.75
FPR = 0.201
0.50
0.25
0.00
0.00 0.25 0.50 0.75 1.00
False Positive Rate

+ 27

threshold p = 0.50
Model
Pr(Y = 1) < 0.50 Pr(Y = 1) > 0.50
Churn (Y = 1) 278 283
1.00
TPR = 0.504
True Positive Rate

0.75
0.50
FPR = 0.090
0.25
0.00
0.00 0.25 0.50 0.75 1.00
False Positive Rate

+ 28

threshold p = 0.99
Model
Pr(Y = 1) < 0.99 Pr(Y = 1) > 0.99
Churn (Y = 1) 561 0
1.00
TPR = 0.000
True Positive Rate

0.75
0.50
FPR = 0.000
0.25
0.00
0.00 0.25 0.50 0.75 1.00
False Positive Rate

+ 29

threshold p = 0.10
Model
Pr(Y = 1) < 0.10 Pr(Y = 1) > 0.10
Reality No Churn (Y = 0) 724 825
Churn (Y = 1) 31 530
1.00
TPR = 0.945
True Positive Rate

0.75
0.50
FPR = 0.533
0.25
0.00
0.00 0.25 0.50 0.75 1.00
False Positive Rate

+ 30

threshold p = 0.001
Model
Pr(Y = 1) < 0.001 Pr(Y = 1) > 0.001
Reality No Churn (Y = 0) 0 1,549
Churn (Y = 1) 0 561
1.00
TPR = 1.00
True Positive Rate

0.75
FPR = 1.00
0.50
0.25
0.00
0.00 0.25 0.50 0.75 1.00
False Positive Rate

+ 31
ROC Curve
n The ROC curve plots the TPR and FPR for every
break-even threshold p between 0.0 and 1.0
n ROC curve can also be drawn for LDA, and for any
method that predicts probabilities
1.0
0.8
True positive rate
0.6
0.4
0.2
0.0
0.0 0.2 0.4 0.6 0.8 1.0
False positive rate

+ 32
The Naïve Baseline Model

n Naïve baseline model:
n Choose a value of p between 0.0 and 1.0
n Then classify every observation as Success with probability p
and as Failure with probability 1-p
n This model does not consider any of the data

n (Analogous to the naïve baseline of the linear regression model)
n Naïve baseline model has true positive rate p, because p

proportion of the positive observations will be correctly
classified as positive
n Naïve model has false positive rate p, because p proportion of

the negative observations will be incorrectly classified as
positive
n What is the accuracy of the naïve baseline model?

+ 33
Naïve Baseline Model with p = 0.20
n TPR = 0.2
1.0
n FPR = 0.2
0.8
True positive rate
0.6
0.4
0.2
●
0.0
0.0 0.2 0.4 0.6 0.8 1.0
False positive rate

+ 34
n TPR = 0.5
1.0
n FPR = 0.5
0.8
True positive rate
0.6
●
0.4
0.2
●
0.0
0.0 0.2 0.4 0.6 0.8 1.0
False positive rate

+ 35
n TPR = 0.8
1.0
n FPR = 0.8
0.8
●
True positive rate

0.6
●
0.4
0.2
●
0.0
0.0 0.2 0.4 0.6 0.8 1.0
False positive rate

+ 36
ROC Curve and Naïve Baseline Curve
1.0
0.8
True positive rate
0.6
0.4
0.2
0.0
0.0 0.2 0.4 0.6 0.8 1.0
False positive rate

+ 37
Area Under the ROC Curve (AUC)
n We want ROC curves that simultaneously achieve a high

TPR and low FPR
n This corresponds to a high area under the ROC curve,
which is called the AUC (Area Under the Curve)
n Maximum AUC: 1.000
n AUC of our model: 0.841
n AUC of naïve baseline: 0.500
n Similar in spirit to R2 (and OSR2), the AUC is a unit-free
measure of model quality that is used to evaluate the
overall quality of a logistic regression model

+ 38
Interpreting the AUC
n Interpretation: given a randomly selected

positive observation (customer who churned)
and a randomly selected negative observation
(customer who did not churn), AUC is the
likelihood that the model would correctly
differentiate which is which
n That is, it is the likelihood that the model would assign
a higher churn probability to the customer who
churned
n AUC measures the model’s discriminative ability

+
Linear Discriminant Analysis

+ 40
n Do we really need another model for predicting

probabilities?
n Yes and no…
n Typically logistic regression is preferred
n Linear discriminant analysis has some advantages

in certain situations
n LDA is popular for multiclass classification – when there
are more than 2 response categories
n LDA is more “stable” in certain situations

+ 41
n Dependent variable can take on one of K possible

values Y 2 {1, . . . , K}
n Model:
n Assume that we know the prior marginal probability
distribution of Y :
⇡k = Pr(Y = k)
n Given that Y = k, we know the distribution of the feature
vector X
n (Say X has density function fk (x) )

+ 42
n LDA assumes that the data was generated

according to the following “generative process”:
n Sample Y according to probabilities (⇡1 , ⇡2 , . . . , ⇡K )
n Given Y = k , sample X from density function fk (x)
n This process is repeated for each data point
n Note that this process “flips around” how

prediction works – we are usually given X and
asked to predict Y. Pr(X|Y=k)
n Makes sense in some situations, e.g., Y corresponds to a
person’s biological sex assigned at birth

+ 44
n Linear Discriminant Analysis makes the following

additional assumptions:
n Given that Y = k, X is normally distributed with mean
vector µk
n Regardless of which class we belong to (i.e., the value of Y),
X has the same variance/correlations (covariance matrix)
n When p = 1, these assumptions are:

n Given Y = k, X ⇠ N (µk ,
2
) ( does not depend on k)
n In other words, ✓ ◆
1 1
fk (x) = p exp 2
(x µk ) 2
2⇡ 2
+ 45
Where does the “Linear” come

from?
n Again, assume p = 1, and given Y = k, X ⇠ N (µk , 2
)
n Define the discriminant functions:
n Then, if we are given X = x, choosing k to maximize:

⇡k fk (x)
Pr(Y = k|X = x) = PK
l=1 ⇡l fl (x)
n is the same as choosing k to maximize

+ 46
Linear Discriminant Analysis,

Estimating the Parameters
n What are the parameters of the model?
n How do we estimate the parameters?

+ 47

n Use maximum likelihood estimation (formulas in
this case) to estimate:
n i) (⇡1 , ⇡2 , . . . , ⇡K ) (marginal probabilities)
n ii) µ = (µ1 , . . . , µK ) (in class means)
n iii) (common variance)

+ 48

n Use maximum likelihood estimation (formulas in
this case) to estimate:
n i) (⇡1 , ⇡2 , . . . , ⇡K ) (marginal probabilities)
n ii) µ = (µ1 , . . . , µK ) (in class means)
n iii) (common variance)
n This leads to somewhat intuitive formulas:

n ( observations belong to class k)
n (within class sample averages)
n (weighted average of sample

variances with bias correction)
+ 51
5
4
np =1
3
2
1
0
−4 −2 0 2 4 −3 −2 −1 0 1 2 3 4
np =2
x2
x2
x1 x1

+ 52
Linear Decision Boundaries when

p = 2 and K = 3
n LDA fits a linear decision boundary
4
4
2
2
X2
X2
0
0
−2
−2
−4
−4
−4 −2 0 2 4 −4 −2 0 2 4
X1 X1

+ 54
LDA vs. Logistic Regression
n Sometimes logistic regression can perform poorly (for

example, if the two classes are “well separated” or
sometimes if n is small)
n Often both methods perform similarly
n Usually if this is the case, logistic regression is

preferred
n Easier to interpret
n Nice statistical properties
n Confusion matrices, ROC curves, and related concepts

all apply to LDA as well

+ 55
LDA vs. Logistic Regression for

Churn Prediction
1.0
0.8
n Logistic = blue
True positive rate
0.6
n LDA = red
0.4
n Similar performance
like this is typical
0.2
0.0
0.0 0.2 0.4 0.6 0.8 1.0
False positive rate

+ 56
Analytics for Customer Retention
n Churn rates in telecom are generally going down
n Predictiveanalytics is used extensively in

managing customer retention
2008 2015
Carrier Annualized Churn Annualized Churn
Verizon Postpaid: 15.6% Postpaid: 13.6%
AT&T Postpaid: 18.4% Postpaid: 14.8%
Sprint Nextel Postpaid: 23.3% Postpaid: 22.7%

Prepaid: 65.2% Prepaid: 39.0%
T-Mobile Overall: 43.9% Postpaid: 15.5%
Prepaid: 42.1%
+ 57
n Some of the figures in this presentation are taken

from “An Introduction to Statistical Learning, with
applications in R” (Springer, 2013) with permission
from the authors: G. James, D. Witten, T. Hastie and
R. Tibshirani

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+

Week 4 – Predicting Loan Repayment and

n If dependent variable is binary (i.e. yes/no) à classification such as

n Business objectives will inform which performance measures are most

n Many statistical measures to assess performance

n Many different modelling approaches (and we’ll discuss many more) –

IEOR 242, Spring 2020 - Week 4

n Final Project Groups – Need to Finalize ASAP

n Project topic requires review from Instructor or GSI

IEOR 242, Spring 2020 - Week 4

n Guest Lecture on Risk Modelling for Cyber Perils

n Linear Discriminant Analysis

IEOR 242, Spring 2020 - Week 4

Customer Retention/Churn in Telecom

n US telecom market is pretty much saturated

n It is a lot harder to acquire a new customer than it

n Cost of acquiring a new customer is typically five

IEOR 242, Spring 2020 - Week 4

Churn Rates of the Top Four Carriers

Verizon 1.21% 13.6%

AT&T 1.33% 14.8%

Sprint Nextel 2.76% 28.5%

T-Mobile 2.41% 25.4%

IEOR 242, Spring 2020 - Week 4

n Call Comcast at end of contract and request a

n Often they’ll offer a discount instantly! (such as a

IEOR 242, Spring 2020 - Week 4

Price Reduction Decision Tree

Identifying High-Risk Customers

n A customer is a low churn-risk if we expect to lose money from a

n We will only offer price reductions to high churn-risk customers

n More broadly, this is about Customer

n Approaches to limit churn

IEOR 242, Spring 2020 - Week 4

IEOR 242, Spring 2020 - Week 4 11

Customer Retention Data

n Dependent variable: Whether the customer

IEOR 242, Spring 2020 - Week 4

Customer Retention Data

IEOR 242, Spring 2020 - Week 4

Training and Testing Set (Random Split)

Churn MonthlyCharges ... Contract 70% Training Set (n=4,922)

IEOR 242, Spring 2020 - Week 4

Logistic Regression for Churn

n How do we deal with variables like

n We will walk through training this model in R

IEOR 242, Spring 2020 - Week 4

Logistic Regression Output

(Dispersion parameter for binomial family taken to be 1)

Number of Fisher Scoring iterations: 6

IEOR 242, Spring 2020 - Week 4

Logistic Regression Output after

(Dispersion parameter for binomial family taken to be 1)

Number of Fisher Scoring iterations: 6

IEOR 242, Spring 2020 - Week 4

Logistic Regression Output after also

(Dispersion parameter for binomial family taken to be 1)

Null deviance: 5699.5 on 4921 degrees of freedom

IEOR 242, Spring 2020 - Week 4

Price Reduction Decision Tree

Using the Logistic Regression

n Let’s use the logistic regression model to identify

IEOR 242, Spring 2020 - Week 4