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Is hazard or probit more accurate in predicting financial distress? Evidence from U.S. bank failures

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  • Cole, Rebel A.
  • Wu, Qiongbing

Abstract

We compare the out-of-sample forecasting accuracy of the time-varying hazard model developed by Shumway (2001) and the one-period probit model used by Cole and Gunther (1998). Using data on U.S. bank failures from 1985 – 1992, we find that, from an econometric perspective, the hazard model is more accurate than the probit model in predicting bank failures, but this improvement in accuracy results from incorporating more recent information in the hazard, but not the probit, model. When we limit both models to the same information set, we find that the one-period probit model is slightly more accurate than the time-varying hazard model. We also find that a parsimonious specification of the one-period probit model fit to data from the 1980s performs surprisingly well in forecasting bank failures during 2009 – 2010.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 24688.

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Date of creation: 22 Feb 2009
Date of revision: 01 Aug 2010
Handle: RePEc:pra:mprapa:24688

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Related research

Keywords: bank; bank failure; failure prediction; financial crisis; forecasting; hazard model; probit model; static model; time-varying covariates;

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  1. Asli Demirgüç-Kunt, 1989. "Modeling large commercial-bank failures: a simultaneous-equation analysis," Working Paper 8905, Federal Reserve Bank of Cleveland.
  2. Til Schuermann & Björn-Jakob Treutler & Scott M. Weiner & M. Hashem Pesaran, 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," CESifo Working Paper Series 995, CESifo Group Munich.
  3. Ross Levine, 2004. "Finance and Growth: Theory and Evidence," NBER Working Papers 10766, National Bureau of Economic Research, Inc.
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  5. Agarwal, Vineet & Taffler, Richard, 2008. "Comparing the performance of market-based and accounting-based bankruptcy prediction models," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1541-1551, August.
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  10. Bonfim, Diana, 2009. "Credit risk drivers: Evaluating the contribution of firm level information and of macroeconomic dynamics," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 281-299, February.
  11. Rebel A. Cole & Jeffery W. Gunther, 1993. "Separating the likelihood and timing of bank failure," Financial Industry Studies Working Paper 93-2, Federal Reserve Bank of Dallas.
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  13. Rebel Cole & Jeffery Gunther, 1998. "Predicting Bank Failures: A Comparison of On- and Off-Site Monitoring Systems," Journal of Financial Services Research, Springer, vol. 13(2), pages 103-117, April.
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  18. Rebel A. Cole & Jeffery W. Gunther, 1995. "FIMS: a new monitoring system for banking institutions," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-15.
  19. Molina, Carlos A., 2002. "Predicting bank failures using a hazard model: the Venezuelan banking crisis," Emerging Markets Review, Elsevier, vol. 3(1), pages 31-50, March.
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  23. Craig O. Brown & I. Serdar Dinç, 2005. "The Politics of Bank Failures: Evidence from Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 120(4), pages 1413-1444, November.
  24. Männasoo, Kadri & Mayes, David G., 2009. "Explaining bank distress in Eastern European transition economies," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 244-253, February.
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