Taking the Twists into Account: Predicting Firm Bankruptcy Risk with Splines of Financial Ratios
AbstractWe demonstrate improvements in predictive power when introducing spline functions to take account of highly non-linear relationships between firm failure and earnings, leverage, and liquidity in a logistic bankruptcy model. Our results show that modeling excessive non-linearities yields substantially improved bankruptcy predictions, on the order of 70 to 90 percent, compared with a standard logistic model. The spline model provides several important and surprising insights into non-monotonic bankruptcy relationships. We find that low-leveraged and highly profitable firms are riskier than given by a standard model. These features are remarkably stable over time, suggesting that they are of a structural nature.
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Bibliographic InfoPaper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 256.
Length: 51 pages
Date of creation: 01 Nov 2011
Date of revision:
bankruptcy risk model; micro-data; logistic spline regression; …nancial ratios;
Find related papers by JEL classification:
- C41 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Duration Analysis; Optimal Timing Strategies
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
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