Redesigning Ratings: Assessing the Discriminatory Power of Credit Scores under Censoring

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Redesigning Ratings: Assessing the Discriminatory Power of Credit Scores under Censoring

by Holger Kraft of Fraunhofer ITWM
Gerald Kroisandt of Fraunhofer ITWM, and
Marlene Müller of Fraunhofer ITWM

June 29, 2004

Abstract: In the light of Basel II, redesigning rating systems has been becoming an important issue for banks and other financial institutions. The available data base for this task typically contains only the accepted credit applicants and is thus censored. To evaluate existing and alternative rating systems, we would actually need the full data base of all past credit applicants. In this paper we discuss how to assess the performance of credit ratings under the assumption that for credit data only a part of the defaults and non-defaults is observed. The paper investigates criteria that are based on the difference of the score distributions under default and non-default such as the accuracy ratio. We show how to estimate bounds for these criteria in the usual situation that the bank storages only data of the accepted credit applicants.

JEL Classification: G21.

Keywords: discriminatory power, censored data, Gini coefficient, accuracy ratio.

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