In the context of bankruptcy prediction models, your textbook calls the Type I e
ID: 2735186 • Letter: I
Question
In the context of bankruptcy prediction models, your textbook calls the Type I error the more costly kind of an error. It is because it causes a lender to:
Not give loan to a firm that is going to stay healthy, incorrectly fearing that it will go bankrupt.
Give loan to a firm that is going to bankrupt, incorrectly thinking that it will not.
Not do business with firms that cannot be judged by the model.
Assume that all firms are equally likely to go bankrupt.
Not give loan to a firm that is going to stay healthy, incorrectly fearing that it will go bankrupt.
Give loan to a firm that is going to bankrupt, incorrectly thinking that it will not.
Not do business with firms that cannot be judged by the model.
Assume that all firms are equally likely to go bankrupt.
Explanation / Answer
Answer: Give loan to a firm that is going to bankrupt, incorrectly thinking that it will not.
(The bankruptcy prediction continually refers to Type I and Type II errors. Type I errors are the misclassification of bankrupt firms as non-bankrupt. Type II errors are the reverse - non bankrupt firms misclassified as bankrupt firms.)