Forecasting Corporate Bankruptcy: Optimizing the Performance of the Mixed Logit Model

24 Pages Posted: 17 Aug 2007

See all articles by David A. Hensher

David A. Hensher

University of Sydney Business School

Stewart Jones

University of Sydney – School of Business

Abstract

In recent studies, Jones and Hensher (2004, 2005) provide an illustration of the usefulness of advanced probability modelling in the prediction of corporate bankruptcies, insolvencies and takeovers. Mixed logit (or random parameter logit) is the most general of these models and appears to have the greatest promise in terms of underlying behavioural realism, desirable econometric properties and overall predictive performance. It suggests a number of empirical considerations relevant to harnessing the maximum potential from this new model (as well as avoiding some of the more obvious pitfalls associated with its use). Using a three-state failure model, the unconditional triangular distribution for random parameters offers the best population-level predictive performance on a hold-out sample. Further, the optimal performance for a mixed logit model arises when a weighted exogenous sample maximum likelihood (WESML) technique is applied in model estimation. Finally, we suggest an approach for testing the stability of mixed logit models by re-estimating a selected model using varying numbers of Halton intelligent draws. Our results have broad application to users seeking to apply more accurate and reliable forecasting methodologies to explain and predict sources of firm financial distress better.

Suggested Citation

Hensher, David A. and Jones, Stewart, Forecasting Corporate Bankruptcy: Optimizing the Performance of the Mixed Logit Model. Abacus, Vol. 43, No. 3, pp. 241-364, September 2007. Available at SSRN: https://ssrn.com/abstract=1007542 or http://dx.doi.org/10.1111/j.1467-6281.2007.00228.x

David A. Hensher

University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia
+ 61 2 9351 0071 (Phone)
+ 61 2 9351 0088 (Fax)

HOME PAGE: http://www.its.usyd.edu.au/about_itls/staff/davidh.asp

Stewart Jones (Contact Author)

University of Sydney – School of Business ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

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