LO 33.6: Discuss the measurement and monitoring o f a scorecard performance

LO 33.6: Discuss the measurement and monitoring o f a scorecard performance including the use o f cumulative accuracy profile (CAP) and the accuracy ratio (AR) techniques.
Credit scoring is used as a means of predicting default risk, such that high (low) scores on the scorecard are assigned to strong (weak) credits. In assessing the performance of the scorecard, a cumulative accuracy profile (CAP) and the accuracy ratio (AR) are often used. The CAP shows the population distribution based on credit scores (and therefore risk) versus the percentage of actual defaults.
Figure 1: Cumulative Accuracy Profile and Accuracy Ratio
Perfect Model (5% default rate)
Actual Rating Model (cumulative % defaults)
(cid:31)—————- Population Distribution Based on Credit Scores —————-(cid:31)
High Risk
Low Risk
Page 258
2018 Kaplan, Inc.
Topic 33 Cross Reference to GARP Assigned Reading – Crouhy, Galai, and Mark, Chapter 9
Lines plotted on the graph include the perfect model line, random model line, and observed cumulative default percentage line defined as follows:

In a perfect model, if the bank predicts, for example, 3% of its accounts will default over a specific period, 100% of those defaults will come from the riskiest 3% of the population.
A random model will assume 5% of the defaults will come from the riskiest 5%, 20%
will come from the riskiest 20%, etc.
The observed cumulative default line represents the actual defaults observed by the bank.
The area between the perfect model and the random model is represented by Ap, while the area between the observed cumulative default percentage line and the random line is represented by AR. The accuracy ratio (AR) is defined as AR/Ap, with a ratio close to 1 implying a more accurate model.
A scoring model must be monitored on a regular basis due to underlying changes in the population as well as potential product changes.
T r a d e o f f b e t w e e n C r e d i t w o r t h i n e s s a n d P r o f i t a b i l i t y

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