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FRM Part II · FRM Exam Part II · Credit Scoring and Rating

A retail lender builds a scorecard by converting each predictor into bins and assigning each bin a weight of evidence (WoE) computed as ln(proportion of goods / proportion of bads). A bin has a negative WoE. What does this indicate?

A negative weight of evidence means the bin holds a smaller proportion of goods than of bads, so applicants in that bin are riskier than the portfolio average. A positive value signals lower risk, and a value near zero signals little discrimination.

  1. AThe bin contains a higher share of bads than goods relative to the overall portfolio distributionCorrect
  2. BThe bin contains a higher share of goods than bads relative to the overall portfolio distribution
  3. CThe bin has too few observations to be used in the scorecard
  4. DThe predictor has no discriminatory power in that bin

Explanation

WoE = ln(%goods/%bads). A negative value means %goods < %bads, so the bin is riskier than average. A positive WoE would indicate the opposite. A WoE near zero, not negative, signals little discrimination.

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