Question

When a bank that is in poor financial condition is misclassified as financially strong, the misclassification cost is much higher than when a financially strong bank is misclassified as weak.

To minimize the expected cost of misclassification, the cutoff value for classification (which is currently at 0.5) should be increased (TRUE/FALSE?)

Answer 1

Answer: False

Step-by-step explanation:

This is indeed a dangerous scenario especially when the bank which is weak is classified as strong. The best thing to do in such scenario is to decrease the cutoff, in order to minimize the expected misclassification because at lower cutoffs, we classify records as weak. Doing this saves the bank.