Institutions must search for the most appropriate transformation of the dependent and the independent variables, in order to maximise the explanatory power of models. If some variables do not need to be transformed, such conclusion must be clearly stated and justified in the model development documentation.
6.4.2
The choice of variable transformation must neither be random nor coincidental. Transformations must be justified by an economic rationale. Amongst others, common transformations include (i) relative or absolute differencing between variables, (ii) logarithmic scaling, (iii) relative or absolute time change, (iv) ranking and binning, (v) lagging, and (vi) logistic or probit transformation. Quadratic and cubic transformations are possible but should be used with caution, backed by robust economic rationale, and should be used with a clear purpose in mind.