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FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment

A bank uses a scorecard that was developed on data from a benign economic period. Management wants to know whether the model's predicted default rates match realized default rates by rating grade over the past year. Which validation activity addresses this question?

Calibration backtesting answers the question because it compares predicted default probabilities with realized default frequencies for each grade. KS and AUC measure ranking power, and the population stability index checks for shifts in the score distribution, not accuracy of PD levels.

  1. ACalibration backtesting of predicted versus observed default frequenciesCorrect
  2. BComputing the Kolmogorov-Smirnov statistic to measure ranking power
  3. CStability analysis of the score distribution using the population stability index
  4. DComputing the AUC to assess discrimination

Explanation

Comparing predicted PDs with realized default rates by grade tests calibration. KS and AUC test discrimination, while the population stability index tests whether the applicant population has shifted. Only calibration backtesting answers whether predicted levels match outcomes.

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