Risk Score
Contents
Definition
A Risk Score is a number (Score) that aims to assess and quantify a level of Risk associated with a system, process or entity.
Conceptually a Risk Score is a Risk Model. Implicit in the construction / compilation of the score is a casual, cause and effect relation that links the contributions to the score to a certain level of risk (an uncertain future realization)
Usage
Within a Risk Taxonomy any risk / Risk Factor that admits techniques from Quantitative Risk Management may benefit from the construction of risk scores.
Risk scores are used widely in many sectors, e.g., medical sector, biostatistics, banking, insurance are prominent examples. They are typically produced via different types of scorecards.
Advantages
Risk Scores are popular tools as they have a number of advantages:
- They are (generally) simple to calculate using scorecards
- They are easy to communicate and interpret:
- The result (score) is a single number that is (typically) placed in a pre-determined scale
- They allow the aggregation of risk contributions
- They are easilty integrated with decision making: E.g Credit Decisioning based on threshold values
Structure
A risk scoring method is composed of the following components:
- A set of consistent rules (or weights) that assign a numerical value ("points") to each risk factor that reflects the estimation of underlying risk
- Formulas (typically a simple sum of all accumulated points) that calculates the Partial Score
- A final score as the weighted sum of all partial scores
Estimation
- Expert models rely on empirical assignement of weights (Expert Scorecards)
- Statistical Estimation is done on the basis of data for both risk factors (covariates) and risk outcomes (risk realizations)
Issues and Challenges
- Informal use of risk scores may lack the rigor of formal Model Validation and assessment / management of Model Risk and thus suffer from Bias or Blind Spot.
