Pitfalls and Remedies in Testing the Calibration Quality of Rating Systems
41 Pages Posted: 24 Aug 2009 Last revised: 5 Nov 2009
Date Written: November 4, 2009
Testing calibration quality by means of backtesting is an integral part in the validation of credit rating systems. Against this background this paper provides a comprehensive overview of existing testing procedures. We study the procedures'deficiencies theoretically and illustrate their impact empirically. Based on the insights gained thereof, we develop enhanced hybrid testing procedures which turn out to be superior to the commonly applied methods. We also propose computationally efficient algorithms for our calibration tests. Finally, we are able to demonstrate empirically that our method outperforms existing tests in a scenario analysis using rating data of Moody's.
Keywords: Rating System, Validation, Calibration Quality
JEL Classification: G20, C49
Suggested Citation: Suggested Citation