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

A bank validates a retail scorecard and finds that the cumulative distribution of scores of defaulters and non-defaulters has a maximum vertical separation (KS statistic) of 0.45. Which interpretation is most appropriate?

A KS of 0.45 means the largest difference between the cumulative share of bad borrowers and the cumulative share of good borrowers across score cutoffs is 45 percentage points. It measures discriminatory power, not accuracy at every cutoff, portfolio default probability, or AUC.

  1. AThe model correctly classifies 45% of all borrowers at every cutoff
  2. BThe maximum gap between the cumulative proportions of bad and good borrowers across score cutoffs is 45 percentage pointsCorrect
  3. CThe probability of default for the portfolio is 45%
  4. DThe area under the ROC curve is 0.45

Explanation

The Kolmogorov-Smirnov statistic measures the largest difference between the cumulative score distributions of defaulters and non-defaulters at some cutoff. It is not an accuracy rate, a PD, or an AUC; an AUC of 0.45 would be worse than random.

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