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

A lender uses a discriminant-type score, the Altman Z-score, to screen a manufacturing borrower. Which feature of such a model is most important to recognize when applying it to a borrower in a very different industry and country?

The key point is that the coefficients and cutoffs were estimated on a specific sample, so the model may not transfer well to other industries or countries without recalibration. The score ranks risk rather than giving a calibrated PD, and judgment remains necessary.

  1. ACoefficients were estimated on a specific sample, so discriminatory power and cutoffs may not transfer without recalibrationCorrect
  2. BThe score directly outputs a calibrated one-year PD that is valid for any firm
  3. CThe model uses only market-based inputs that adjust automatically to new regimes
  4. DThe Z-score eliminates the need for judgmental review

Explanation

Z-score models are fitted on a particular sample of firms and period, so weights and cutoff zones reflect that population. Applying them elsewhere requires validation or recalibration. The raw score is a ranking measure, not a calibrated PD, and it uses accounting ratios, not purely market inputs.

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