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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

A bank validates its internal rating system by comparing the ranking of obligors with subsequent default outcomes. The validation team computes the accuracy ratio from the cumulative accuracy profile (CAP). Which statement about the accuracy ratio is correct?

The accuracy ratio is the area between the model's CAP curve and the random-model line divided by the same area for a perfect model. It measures discriminatory power, meaning how well the system ranks defaulters as riskier, rather than calibration of default probabilities.

  1. AIt equals the area between the model's CAP curve and the random model line, divided by the same area for a perfect modelCorrect
  2. BIt equals the proportion of defaulters assigned to the best rating grade
  3. CIt measures whether predicted default probabilities equal realized default rates in each grade
  4. DIt is the percentage of non-defaulters correctly classified at a chosen cutoff

Explanation

The accuracy ratio compares the area between the model CAP and the random (45-degree) line with the corresponding area for a perfect model. It measures discriminatory power (ranking), not calibration. The calibration option describes a different test, such as a binomial test.

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