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Each of the available borrower characteristics contains information on his/her credit quality.
It is only natural that some characteristics are less important than others for the purpose of assessing creditworthiness; for example, the borrower's income bracket is more important than the borrower's family status.
How can we assess the rationality and effectiveness of the characteristics' use in the process of developing the scorecard?
For that purpose, we use the Information Value (IV) criterion:
Here, per each category of the selected borrower characteristic:
DistrGood i - is the share of "good" borrowers in the category
DistrBad i - is the share of "bad" borrowers in the category.
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Value of IV
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Statistical strength
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less than 0.02
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a very weak statistical relation
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0.02 – 0.1
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a weak statistical relation
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0.1 – 0.3
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an average statistical relation
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0.3 – 0.5
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a strong statistical relation
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greater than 0.5
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an extremely strong statistical relation
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IMPORTANT: Borrower characteristics that have an extremely strong statistical relationship can nullify the contribution of other less informative characteristics, that is why their use in the process of scorecard development requires special attention.
In the example, the LTV (Loan to Value Ratio) characteristic has an extremely strong statistical relationship, while the indicator that characterizes the borrower's family status potentially has no bearing on creditworthiness.
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