Estimation of Default Probabilities with Support Vector Machines
AbstractPredicting default probabilities is important for firms and banks to operate successfully and to estimate their specific risks. There are many reasons to use nonlinear techniques for predicting bankruptcy from financial ratios. Here we propose the so called Support Vector Machine (SVM) to estimate default probabilities of German firms. Our analysis is based on the Creditreform database. The results reveal that the most important eight predictors related to bankruptcy for these German firms belong to the ratios of activity, profitability, liquidity, leverage and the percentage of incremental inventories. Based on the performance measures, the SVM tool can predict a firms default risk and identify the insolvent firm more accurately than the benchmark logit model. The sensitivity investigation and a corresponding visualization tool reveal that the classifying ability of SVM appears to be superior over a wide range of the SVM parameters. Based on the nonparametric Nadaraya-Watson estimator, the expected returns predicted by the SVM for regression have a significant positive linear relationship with the risk scores obtained for classification. This evidence is stronger than empirical results for the CAPM based on a linear regression and confirms that higher risks need to be compensated by higher potential returns.
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Bibliographic InfoPaper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-077.
Length: 43 pages
Date of creation: Nov 2006
Date of revision:
Support Vector Machine; Bankruptcy; Default Probabilities Prediction; Expected Profitability; CAPM.;
Find related papers by JEL classification:
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-11-25 (All new papers)
- NEP-ECM-2006-11-25 (Econometrics)
- NEP-RMG-2006-11-25 (Risk Management)
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