Refining Understanding of Corporate Failure through a Topological Data Analysis Mapping of Altman's Z-Score Model

Wanling Qiu, Simon Rudkin and Pawel Dlotko

Papers from arXiv.org

Abstract: Corporate failure resonates widely leaving practitioners searching for understanding of default risk. Managers seek to steer away from trouble, credit providers to avoid risky loans and investors to mitigate losses. Applying Topological Data Analysis tools this paper explores whether failing firms from the United States organise neatly along the five predictors of default proposed by the Z-score models. Firms are represented as a point cloud in a five dimensional space, one axis for each predictor. Visualising that cloud using Ball Mapper reveals failing firms are not often neighbours. As new modelling approaches vie to better predict firm failure, often using black boxes to deliver potentially over-fitting models, a timely reminder is sounded on the importance of evidencing the identification process. Value is added to the understanding of where in the parameter space failure occurs, and how firms might act to move away from financial distress. Further, lenders may find opportunity amongst subsets of firms that are traditionally considered to be in danger of bankruptcy but actually sit in characteristic spaces where failure has not occurred.

Date: 2020-04
New Economics Papers: this item is included in nep-cfn and nep-rmg
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