Discriminatory Power - An Obsolete Validation Criterion?

43 Pages Posted: 25 Mar 2008

See all articles by Manuel Lingo

Manuel Lingo

Oesterreichische Nationalbank (OeNB); Vienna University of Economics and Business Administration

Gerhard Winkler

Oesterreichische Nationalbank (OeNB); Vienna University of Economics and Business Administration

Date Written: February 2008

Abstract

In this paper we analyse two common measures of discriminatory power - the Accuracy Ratio and the Area Under the Receiver Operator Characteristic - in a probabilistic framework. Under the assumption of a random default event, we verify that the measures will be portfolio dependent as discovered by Hamerle et al. (2003) and furthermore stochastic as indicated by Blochwitz et al. (2005). As an extension of these two papers we first study how the structure of a portfolio influences the measures. Furthermore we demonstrate that the measures contain information about a rating system's calibration quality. To this end a testing procedure is developed that also allows for a comparison of the measures across different portfolios. Our analysis leads to the final conclusion that high granularity and good calibration quality are sufficient to maximize attainable discriminatory power and are thus the sole criteria to be considered in any validation exercise.

Keywords: Credit Risk, Validation, Discriminatory Power, Calibration Quality, ROC, CAP

JEL Classification: G20, C49

Suggested Citation

Lingo, Manuel and Winkler, Gerhard, Discriminatory Power - An Obsolete Validation Criterion? (February 2008). Available at SSRN: https://ssrn.com/abstract=1026242 or http://dx.doi.org/10.2139/ssrn.1026242

Manuel Lingo (Contact Author)

Oesterreichische Nationalbank (OeNB) ( email )

Otto-Wagner-Platz 3
1090 Vienna
Austria

Vienna University of Economics and Business Administration

Augasse 2-6
Vienna A-1090
Austria

Gerhard Winkler

Oesterreichische Nationalbank (OeNB) ( email )

Otto-Wagner-Platz 3
1090 Vienna
Austria

Vienna University of Economics and Business Administration ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
364
Abstract Views
2,260
rank
91,370
PlumX Metrics