Rules for a coherent real estate risk scoring

Abstract

Purpose Scoring is a widely used, long-established, and universally applicable method of measuring risks, especially those that are difficult to quantify. Unfortunately, the scoring method is often misused in real estate practice and underestimated in academia. The purpose of this paper is to supplement the literature with general rules under which scoring systems should be designed and validated, so that they can become reliable risk instruments. Design/methodology/approach The paper combines the rules, or axioms, for coherent risk measures known from the literature with those for scoring instruments. The result is a system of rules that a risk scoring system should fulfil. The approach is theoretical, based on a literature survey and reasoning. Findings At first, the paper clarifies that a risk score should express the variation of a property’s yield and not of its quality, as it is often done in practice. Then the axioms for a coherent risk scoring are derived, e.g. the independence of the risk factors. Finally, the paper proposes procedures for valid and reliable risk scoring systems, e.g. the out-of-time validation. Practical implications Although it is a theoretical work, the paper also focuses on practical applicability. The findings are illustrated with examples of scoring systems. Originality/value Rules for risk measures and for scoring systems have been established long ago, but the combination is a first. In this way, the paper contributes to real estate risk research and risk management practice.