Predicting bank failures using simple static and time-varying models

44 Pages Posted: 24 Aug 2009 Last revised: 2 Apr 2021

See all articles by Rebel A. Cole

Rebel A. Cole

Florida Atlantic University

Jon Taylor

Florida Atlantic University - Finance

Qiongbing Wu

Western Sydney University

Date Written: March 31, 2021

Abstract


We compare the out-of-sample accuracy of three methodologies—the time-varying hazard model of Shumway (2001), the static probit model used by Cole and Gunther (1998), and a static logistic regression model similar to Cole and White (2012)—in forecasting U.S. bank failures. When we limit all models to financial data available at the time of prediction, we find that the logistic and probit models outperform the hazard model, indicating that the superior performance of hazard model documented in previous empirical research is attributable to use of more timely financial data rather than to incorporation of time-varying covariates. We also find that the logistic model slightly outperforms the probit model. Finally, we also find that a parsimonious specification fit to data over 1985-1993 performs well in forecasting bank failures during 2009-2011—evidence that the characteristics of “distressed banks” have experienced little change over the past two decades despite substantial changes in structure and regulation of the U.S. banking industry. Our findings support supervision focusing on banks’ traditional CAMELS risk ratios. We also add to the literature finding that simpler models outperform more complex models in out-of-sample forecasting.

Keywords: banking crisis, bank failure, bank supervision, CAMELS, failure prediction, financial crisis, hazard model, logit model, offsite monitoring probit model

JEL Classification: G17, G21, G28

Suggested Citation

Cole, Rebel A. and Taylor, Jon and Wu, Qiongbing, Predicting bank failures using simple static and time-varying models (March 31, 2021). Available at SSRN: https://ssrn.com/abstract=1460526 or http://dx.doi.org/10.2139/ssrn.1460526

Rebel A. Cole (Contact Author)

Florida Atlantic University ( email )

College of Business
777 Glades Road
Boca Raton, FL 33431
United States
1-561-297-4969 (Phone)

HOME PAGE: http://rebelcole.com

Jon Taylor

Florida Atlantic University - Finance ( email )

777 Glades Rd
Boca Raton, FL 33431
United States

Qiongbing Wu

Western Sydney University ( email )

169 Macquarie St.
Parramatta
Sydney, NSW 2150
Australia
+61-2-96859805 (Phone)
+61-2-96859105 (Fax)

HOME PAGE: http://www.westernsydney.edu.au/staff_profiles/WSU/associate_professor_linda_wu

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