Credit quality scores

Residential MBSs are characterized as prime and sub-prime, depending on the credit quality of the underlying mortgages. A credit quality score known as FICO measures whether the loan is prime or sub-prime. Home equity, while previously referring to a different type of RMBS, now refers to a sub-prime RMBS transaction. 

If the discriminant score, C, exceeds a certain threshold value (discriminatory value or cutoff value), the credit quality of a corporation will be classified as good, otherwise as poor. The estimation of the discriminant function requires a set of corporations that are already classified as solvent or insolvent (good or poor). Thus it is possible to assess the reliability of the function via the number of misclassified corporations. 

Afterwards, calculations of a variety of parameter combinations are run. The objective is to find a discriminant function with the correct signs for the different coefficients. Only this permits the formation of a function where there is no exception to the rule The higher the score, the higher the credit quality of the corporation. Incorrect signs may result in misclassifications and thus wrong credit assessments. 

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