Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/212324 
Year of Publication: 
2015
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 16/2015
Publisher: 
Bank of Finland, Helsinki
Abstract: 
Use of variability of profits and other accounting-based ratios in order to estimate a firm's risk of insolvency is a well-established concept in management and economics. This paper argues that these measures fail to approximate the true level of risk accurately because managers consider other strategic choices and goals when making risky decisions. Instead, we propose an econometric model that incorporates current and past strategic choices to estimate risk from the profit function. Specifically, we extend the well-established multiplicative error model to allow for the endogeneity of the uncertainty component. We demonstrate the power of the model using a large sample of U.S. banks, and show that our estimates predict the accelerated bank risk that led to the subprime crisis in 2007. Our measure of risk also predicts the probability of bank default both in the period of the default, but also well in advance of this default and before conventional measures of bank risk.
Persistent Identifier of the first edition: 
ISBN: 
978-952-323-059-0
Document Type: 
Working Paper

Files in This Item:
File
Size





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.