From Power Curves to Discriminative Power: Measuring Model Performance of LGD Models

Abstract

Measuring model performance of rating systems is a major task for banks. The concept of discrimination, i.e. the discriminative power, is used in credit risk modeling to assess the quality of a risk model concerning the separation of extreme events. For PD models CAP (Cumulative Accuracy Profile) or ROC (Receiver Operating Characteristic) curves are used to build a quantity called Accuracy Ratio, which is used to measure the discriminative power. These ideas are well known and broadly used in practice. Although such a measure is also desirable for models of the loss given default (LGD models), it is not documented in the literature. In this note we close this gap. We develop a measure for the discriminative power of LGD models based on Lorenz curves. We study first properties and introduce some alternatives for its calculation from a practical point of view.