Myth and Reality of Discriminatory Power for Rating Systems
Wilmott Magazine, 2005, pp. 2-6
12 Pages Posted: 10 Nov 2013
Date Written: July 27, 2004
Under the Revised International Capital Framework, debtors’ credit ratings and probabilities of default in credit portfolios have a key role in determining minimum regulatory capital re-quirements. To measure discriminatory power of rating systems, methods such as the area under a ROC curve, the Accuracy Ratio and PowerStat are often used both in academic stud-ies and in practice. This paper shows that these measures need to be interpreted with caution since their values hinge crucially on the characteristics of the portfolio under consideration and not just on the quality of the rating system.
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