Factors Affecting the Probability of Bankruptcy

Maurice Peat
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Maurice Peat: Discipline of Finance, University of Sydney

No 130, Working Paper Series from Finance Discipline Group, UTS Business School, University of Technology, Sydney

Abstract: The majority of classification models developed have used a pool of financial ratios combined with statistical variable selection techniques to maximise the accuracy of the classifier being employed. Rather than follow an "ad hoc" variable selection process, this paper seeks to provide an economic basis for the selection of variables for inclusion in bankruptcy models, which are based on accounting information. Variables which occur in bankruptcy probability expressions derived from the solution of an stochastic optimising model for a firm are 'proxied' by variables constructed from financial statement data. The random nature of the life time of a single firm provides the rationale for the use of duration or hazard-based statistical methods in the validation of the derived bankruptcy probability expressions. The Cox (1972) proportional hazards model is used to estimate the coefficients and standard errors that are required for the validation of the derived bankruptcy probability expressions. Results of the validation exercise confirm that the variables included in the empirical hazard formulation behave in a way that is consistent with the model of the firm.

Date: 2003-09-01
New Economics Papers: this item is included in nep-acc and nep-ent
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Published as: Peat, M., 2007, "Factors Affecting the Probability of Bankruptcy: A Managerial Decision Based Approach", Abacus, 43(3), 303-324.

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Journal Article: Factors Affecting the Probability of Bankruptcy: A Managerial Decision Based Approach (2007)
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