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Logistic Regression-A Conceptual Framework: Presentation Dr. P.K.Viswanathan Professor (Analytics)

Here are the key steps to determine the optimal mailing strategy: 1. Develop a logistic regression model using the data from the existing customers. 2. Apply the model to predict the probability of purchase for each customer in the holdout sample. 3. Determine a probability cutoff (e.g. 20%) above which customers should receive the mailing. 4. Calculate the expected net profit of this strategy by multiplying the number of customers above the cutoff by the average net profit per customer. 5. Compare the expected net profit of this strategy to other cutoff strategies to determine the optimal one. The optimal mailing strategy maximizes expected net profit by targeting customers with the highest predicted purchase probabilities.

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86 views12 pages

Logistic Regression-A Conceptual Framework: Presentation Dr. P.K.Viswanathan Professor (Analytics)

Here are the key steps to determine the optimal mailing strategy: 1. Develop a logistic regression model using the data from the existing customers. 2. Apply the model to predict the probability of purchase for each customer in the holdout sample. 3. Determine a probability cutoff (e.g. 20%) above which customers should receive the mailing. 4. Calculate the expected net profit of this strategy by multiplying the number of customers above the cutoff by the average net profit per customer. 5. Compare the expected net profit of this strategy to other cutoff strategies to determine the optimal one. The optimal mailing strategy maximizes expected net profit by targeting customers with the highest predicted purchase probabilities.

Uploaded by

Shreenidhi M R
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Logistic Regression-A Conceptual Framework

Presentation
Dr. P.K.Viswanathan
Professor(Analytics)
Logistic Regression-Examples

▪ Banking: What is the likelihood that someone will default on


a loan or prepay her mortgage?

▪ Marketing: What is the likelihood of someone responding to


a mail campaign?

▪ Medicine: What is the likelihood a patient will get well or


die?

▪ Fraud Detection: What is the likelihood a transaction/claim/


is fraudulent?
Why Logistic Regression?

▪ No matter, however hard we try, there is no guarantee in OLS


regression the probability of the dependent variable will be
in the range of 0-1.

▪ In all likelihood, a few observations will go out side 0-1 which


makes no sense in probability.

▪ Hence Logistic Regression is used by Analytics Professionals.


Odds and Probabilities

Probability = Odds/(odds+1)
Odds = Probability/(1-Probability)
Why Odds Anyway?

▪ Odds are used to counteract the fact that linear regression


produces probability values outside the range of 0 and 1.

▪ Going with an odds forces the upper bound on the probability.


The lower bound is achieved by taking the natural log of the
regression value.
Visual of Logit Curve
Logistic Regression

◼ Logistic Regression Equation


The relationship between Probability P and X1, X2, . . . , Xk is
described by the following equation:

𝑒𝑍
P=
(1+𝑒 𝑍 )

Z=b0+b1X1+b2X2+...bkXk
X1, X2, . . . , Xk are the predictor variables

P represents the probability that Y=1


1-P represents the probability that Y=0
Logistic Regression
Maximum Likelihood Estimation(MLE)

When Y=1, L=P


When Y=0, L=1-P.
This is for a single data point. You should multiply for all points.
Maximizing L is same as maximizing Log L (base e).

𝐿𝑜𝑔𝐿 =∑Ylog(P)+∑(1-Y)Log(1-P)
Walk the Talk
Simmons Catalogue1

Simmons’ catalogs are expensive and Simmons


would like to send them to only those customers who
have the highest probability of making a $200 purchase
using the discount coupon included in the catalog.
Simmons’ management thinks that annual spending
at Simmons Stores and whether a customer has a
Simmons credit card are two variables that might be
helpful in predicting whether a customer who receives
the catalog will use the coupon to make a $200
purchase.

1.Adapted from Anderson, Sweeney, and Williams purely for classroom discussion
Simmons Catalogue-Continues
Simmons conducted a study by sending out 100
catalogs, 50 to customers who have a Simmons credit
card and 50 to customers who do not have the card.
At the end of the test period, Simmons noted for each of
the 100 customers:
1) the amount the customer spent last year at Simmons,
2) whether the customer had a Simmons credit card, and
3) whether the customer made a $200 purchase.
The data file that contains the information is in
Logit-Simmons.csv

Develop a logistic regression model, obtain the output


and interpret the results
Example Problem-Books By Mail from Paul Green purely for
Classroom Discussion

• Books By Mail company is interested in offering a new title called The Art History of
Florence to 1000, existing customers. Of these, 83 actually purchased the book, a
response rate of 8.3 percent. Hence, the company sent a test mailing to them in
this regard. The company also sent out an identical mailing to another 1000
customers to serve as holdout sample. The scope of the study primarily confined to
predicting whether a customer will buy the new book or not is based on two input
variables namely months since last purchase and number of art books purchased. The
data files of the existing customers and the holdout sample are given in
“PaulBooks1.csv” and “Paulbooks2.csv” respectively.
Any Practical Value for Books By Mail?

We can assess the operational significance of the model by


using it to determine a mailing strategy for the 1000
customers in the holdout sample and then assessing the
profitability of the strategy. The cost of mailing an offer to
purchase The Art History of Florence is $1; if the customer
responds and purchases the book, then the net profit(after
the cost of mailing) is $6. What should be the mailing
strategy?

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