Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/144336
Authors: 
Mitchell, Janet
Van Roy, Patrick
Year of Publication: 
2007
Series/Report no.: 
Working Paper Research 123
Abstract: 
We address a number of comparative issues relating to the performance of failure prediction models for small, private firms. We use two models provided by vendors, a model developed by the National Bank of Belgium, and the Altman Z-score model to investigate model power, the extent of disagreement between models in the ranking of firms, and the design of internal rating systems. We also examine the potential gains from combining the output of multiple models. We find that the power of all four models in predicting bankruptcies is very good at the one-year horizon, even though not all of the models were developed using bankruptcy data and the models use different statistical methodologies. Disagreements in firm rankings are nevertheless significant across models, and model choice will have an impact on loan pricing and origination decisions. We find that it is possible to realize important gains from combining models with similar power. In addition, we show that it can also be beneficial to combine a weaker model with a stronger one if disagreements across models with respect to failing firms are high enough. Finally, the number of classes in an internal rating system appears to be more important than the distribution of borrowers across classes
Subjects: 
Basel II
failure prediction
internal ratings
model power
rating systems
ROC analysis.
JEL: 
D40
G21
G24
G28
G33
Document Type: 
Working Paper

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