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Credit Scoring and Loan Default
This paper introduces a measure of credit score performance that abstracts from the influence of "situational factors." Using this measure, we study the role and effectiveness of credit scoring that underlied subprime securities during the mortgage boom of 2000-2006. Parametric and nonparametric measures of credit score performance reveal different trends, especially on originations with low credit scores. The paper demonstrates an increasing trend of reliance on credit scoring not only as a measure of credit risk but also as a means to offset other riskier attributes of the origination. This reliance led to deterioration in loan performance even though average credit quality—as measured in terms of credit scores— actually improved over the years.