A generalized ROC approach for the validation of credit rating systems and scorecards

Abstract

Purpose

The purpose of this article is to introduce Receiver Operating Characteristic (ROC) surfaces and hyper‐surfaces within a banking context as natural generalizations of the ROC curve.

Design/methodology/approach

Nonparametric ROC analysis using U‐statistics theory was used.

Findings

Application of the proposed methodology on data from a small size Greek bank illustrates the usefulness of ROC analysis for scoring systems assessment. The area under the ROC curve and the volume under the ROC surface and hyper‐surface are useful diagnostic indices for the assessment of credit rating systems and scorecards. The notion of statistical significance is not adequate for the evaluation of the loan granting strategy of a financial institution.

Originality/value

This article will be of value to financial institutions during the process of evaluation/validation of rating models.

Citation

Xanthopoulos, S.Z. and Nakas, C.T. (2007), "A generalized ROC approach for the validation of credit rating systems and scorecards", Journal of Risk Finance, Vol. 8 No. 5, pp. 481-488. https://doi.org/10.1108/15265940710834762