What is overfitting in the context of risk modeling?

Overfitting occurs when a predictive model learns not just the underlying patterns present in the training data but also the noise and fluctuations that are specific to that data set. This means that the model becomes overly complex, capturing even the random variations within the training set rather than focusing on the true, general relationships that can be used for prediction. As a result, while an overfitted model may perform very well on its training data, it typically performs poorly on unseen data because it does not generalize well.

In the context of risk modeling, overfitting is particularly detrimental because it can result in unreliable predictions, making the model less effective in real-world applications where decisions often depend on predicting future outcomes. This understanding highlights the importance of developing models that strike a balance between complexity and generalization, ensuring that they can adapt to new data while still being accurate in their predictions.