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FRM Part II · FRM Exam Part II · Credit Risk

A bank validates its retail scorecard and finds that the model ranks borrowers well: defaulters consistently receive lower scores than non-defaulters. However, the observed default rate in every score band is about double the model's predicted probability of default. Which statement best describes the model's performance?

The model has good discriminatory power but poor calibration. It ranks defaulters below non-defaulters correctly, yet its predicted default probabilities are only about half the realized default rates, so the levels of PD are wrong even though the ordering of risk is sound.

  1. AGood discriminatory power but poor calibrationCorrect
  2. BPoor discriminatory power but good calibration
  3. CBoth poor discriminatory power and poor calibration
  4. DGood discriminatory power and good calibration

Explanation

Discriminatory power concerns ranking of good versus bad borrowers, which is fine here. Calibration concerns whether predicted PDs match realized default rates, and a doubling of actual defaults shows the PDs are understated. Hence ranking is good but calibration is poor.

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