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Bankruptcy Prediction with Industry Effects

In: Financial Derivatives Pricing Selected Works of Robert Jarrow

Author

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  • SUDHEER CHAVA

    (C. T. Bauer College of Business, University of Houston, USA)

  • ROBERT A. JARROW

    (Johnson Graduate School of Management, Cornell University, USA)

Abstract

AbstractThis paper investigates the forecasting accuracy of bankruptcy hazard rate models for U.S. companies over the time period 1962–1999 using both yearly and monthly observation intervals. The contribution of this paper is multiple-fold. One, using an expanded bankruptcy database we validate the superior forecasting performance of Shumway's (2001) model as opposed to Altman (1968) and Zmijewski (1984). Two, we demonstrate the importance of including industry effects in hazard rate estimation. Industry groupings are shown to significantly affect both the intercept and slope coefficients in the forecasting equations. Three, we extend the hazard rate model to apply to financial firms and monthly observation intervals. Due to data limitations, most of the existing literature employs only yearly observations. We show that bankruptcy prediction is markedly improved using monthly observation intervals. Fourth, consistent with the notion of market efficiency with respect to publicly available information, we demonstrate that accounting variables add little predictive power when market variables are already included in the bankruptcy model.

Suggested Citation

  • Sudheer Chava & Robert A. Jarrow, 2008. "Bankruptcy Prediction with Industry Effects," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 21, pages 517-549 World Scientific Publishing Co. Pte. Ltd..
  • Handle: RePEc:wsi:wschap:9789812819222_0021
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    Keywords

    Derivatives; Options; Hedging; HJM; Black–Scholes; Forwards; Futures; Martingale Measure; Calls; Puts; Market Manipulation; Margin Requirements;

    JEL classification:

    • B26 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Financial Economics
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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