Economic Benefit of Powerful Credit Scoring
42 Pages Posted: 31 Jan 2005
Date Written: January 2005
Abstract
In this paper, we study the economic benefits from using credit scoring models. We contribute to the literature by relating the discriminatory power of a credit scoring model to the optimal credit decision. Given the Receiver Operating Characteristic (ROC) curve of the credit scoring model, we derive a) the profit-maximizing cuttoff regime and b) the pricing curve. In addition, we study a stylized loan market model with banks that differ in the quality of their credit scoring model. We find that profitability varies substantially among lenders. More powerful credit scoring models lead to economically significant differences in credit portfolio performance.
Keywords: Bank loan pricing, credit scoring, discriminatory power, Receiver Operating Characteristic (ROC)
JEL Classification: D40, G21, H81
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