Appraising Credit Ratings: Does the CAP Fit Better than the ROC?

May 1, 2012

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R. John Irwin, and Timothy C Irwin. Appraising Credit Ratings: Does the CAP Fit Better than the ROC?, (USA: International Monetary Fund, 2012) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

ROC and CAP analysis are alternative methods for evaluating a wide range of diagnostic systems, including assessments of credit risk. ROC analysis is widely used in many fields, but in finance CAP analysis is more common. We compare the two methods, using as an illustration the ability of the OECD’s country risk ratings to predict whether a country will have a program with the IMF (an indicator of financial distress). ROC and CAP analyses both have the advantage of generating measures of accuracy that are independent of the choice of diagnostic threshold, such as risk rating. ROC analysis has other beneficial features, including theories for fitting models to data and for setting the optimal threshold, that we show could also be incorporated into CAP analysis. But the natural interpretation of the ROC measure of accuracy and the independence of ROC curves from the probability of default are advantages unavailable to CAP analysis.

Subject: Credit ratings, Income distribution

Keywords: CAP analysis, CAP curve, Ratio, ROC curve, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2012/122
Stock No:

WPIEA2012122
ISBN:

9781475503517
ISSN:

1018-5941

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