TYPE 1 & 2 ERROR

05.01g [my add] In de Servigny's Neyman-Person Decision rule used to classify firms into good/bad credit risk, the null hypothesis is (implicitly): the firm is going to default. Which are the Type I and Type II errors and which is more costly? If null hypothesis: firm is going to default ("bad firm") Type I error (The error of rejecting a hypothesis when it is true) is to make a loan (accept as a credit risk) to a BAD firm Type II error (The error of accepting [not rejecting] a false hypothesis) is deny a loan to a GOOD firm The Type I error is worse, de Servigny: "a Type I error damages the wealth of the bank, given its utility function, whereas a Type II error is only a false alarm" Note: although Type II errors are often more costly, we cannot say this as a general rule. Rather, it depends entirely on the definition of the null hypothesis.