I’m proud to note that FICO’s Johan Jansen van Rensburg and I won the Best Paper Prize at the Credit Scoring and Credit Control XII conference in Edinburgh last week. Our paper was on “Economic Impact Grade Migration Modeling - To Address Pro-Cyclicality in Current Risk Management Practice,” and addresses some of the issues around counter-cyclical risk management that I have addressed in this blog and in FICO’s Insights white paper.
Our paper was selected from nearly 75 papers. FICO also won Best Paper at the last conference, in 2009. Here is the abstract for our presentation in Edinburgh:
There is an emphasis on in-grading counter-cyclicality into the financial system. This is forcing bank executives to look at what tools they need to address pro-cyclicality in current capital and risk management practices. The capital requirements is calculated as a percentage of risk-weighted assets (RWA), but the methodology behind establishing the value of RWA is highly pro-cyclical at most banks.
Traditional credit scoring models can have a significant impact on the volatility of the PDs depending on how Point in Time (PiT) or Through the Cycle (TTC) the underlying models are. Therefore, the level of influence that the economy plays in changing both customer scores and score-level default rates is key to measure the pro-cyclicality.
Economic Impact score-to-odds relationship models can be developed to show the affect of the economy on the default rate at each score range level (PD grade). Further, Grade Migration Models (GMM) are designed to measure the influences different economic conditions have upon a portfolio’s score distribution.
This session will share: • The pro-cyclical problem using traditional scorecard at high level. • A new analytic solution that marries economic change with credit risk metrics to improve counter-cyclical risk and capital management, focusing on grade migration modeling. • Case study results to demonstrate the GMM effectiveness.
If you’re interested in this topic, join us at FICO World 2011, 1-4 November 2011 in New York City. Johan will be presenting along with Raiffeisen, which uses the FICO Economic Impact Service developed based on our research.
