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Economic Benefit of Powerful Credit Scoring

by Andreas Blöchlinger of Credit Suisse, and
Markus Leippold of the Swiss Banking Institute, University of Zürich

July 20, 2005

Abstract: 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, we derive a) the profit-maximizing cutoff and b) the pricing curve. Using these two concepts and a mixture thereof, we study a stylized loan market model with banks differing in the quality of their credit scoring model. Even for small quality differences, the variation in profitability among lenders is large and economically significant. We end our analysis by quantifying the impact on profits when information leaks from a competitor's scoring model into the market.

JEL Classification: D40, G21, H81.

Keywords: Bank loan pricing, Credit scoring, Discriminatory power, Receiver Operating Characteristic (ROC).

Published in: Journal of Banking & Finance, Vol. 30, No. 3, (March 2006), pp. 851-873.

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