Validation of Credit Rating Systems Using Multi-Rater Information
35 Pages Posted: 20 Dec 2005
Date Written: November 2006
We suggest a new framework for the use of multi-rater information in the validation of credit rating systems, applicable in any validation process where rating information from different sources is available. As our validation framework does not rely on historical default information it appears to be particularly useful in situations where such information is inaccessible. We focus on the degree of similarity or - more generally - proximity of rating outcomes stemming from different sources and show that it is important to analyze three major aspects of proximity: agreement, association, and rating bias. We suggest using a weighted version of Cohen's kappa to measure the agreement between two rating systems and we introduce a new measure for rating bias. In contrast to the existing literature we suggest tau-x as a measure of association which is based on the Kemeny-Snell metric and, opposed to other measures, is consistent with a set of basic axioms and should therefore be used in the context of multi-rater information. We provide an illustrative empirical example using rating information stemming from the Austrian Credit Register on partially overlapping sets of customers of 27 banks. Using a multi-dimensional scaling technique in connection with a minimal spanning tree we show that it is possible to consistently detect outliers, i.e., banks with a low degree of similarity to other banks. The results indicate that banks which are less diversified across the size of their loans are more likely to be outliers than others.
Keywords: rating validation, benchmarking, rating agreement, rating association, rating bias, Kemeny-Snell metric, multi-dimensional scaling, minimal spanning tree
JEL Classification: G20, C49
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