How Accurately Can Z‐Score Predict Bank Failure?

28 Pages Posted: 17 Nov 2016

See all articles by Laura Chiaramonte

Laura Chiaramonte

Università degli Studi di Verona, Facoltà di Economia, Dipartimento di Economia Aziendale; Catholic University of the Sacred Heart of Milan - Department of Economics and Business Administration

(Frank) Hong Liu

University of Glasgow - Adam Smith Business School

Federica Poli

Catholic University of the Sacred Heart of Milan - Department of Economics and Business Administration

Mingming Zhou

University of Colorado, Colorado Springs - College of Business

Date Written: December 2016

Abstract

Bank risk is not directly observable, so empirical research relies on indirect measures. We evaluate how well Z‐score, the widely used accounting‐based measure of bank distance to default, can predict bank failure. Using the U.S. commercial banks’ data from 2004 to 2012, we find that on average, Z‐score can predict 76% of bank failure, and additional set of other bank‐ and macro‐level variables do not increase this predictability level. We also find that the prediction power of Z‐score to predict bank default remains stable within the three‐year forward window.

Keywords: Z‐score, bank failure, financial crisis

JEL Classification: E37, G01, G21

Suggested Citation

Chiaramonte, Laura and Liu, (Frank) Hong and Poli, Federica and Zhou, Mingming, How Accurately Can Z‐Score Predict Bank Failure? (December 2016). Financial Markets, Institutions & Instruments, Vol. 25, Issue 5, pp. 333-360, 2016, Available at SSRN: https://ssrn.com/abstract=2870125 or http://dx.doi.org/10.1111/fmii.12077

Laura Chiaramonte (Contact Author)

Università degli Studi di Verona, Facoltà di Economia, Dipartimento di Economia Aziendale ( email )

Via dell'Artigliere, 19
37129 Verona
Italy

Catholic University of the Sacred Heart of Milan - Department of Economics and Business Administration ( email )

20123 Milano
Italy

(Frank) Hong Liu

University of Glasgow - Adam Smith Business School

Glasgow, Scotland
United Kingdom

Federica Poli

Catholic University of the Sacred Heart of Milan - Department of Economics and Business Administration ( email )

20123 Milano
Italy

Mingming Zhou

University of Colorado, Colorado Springs - College of Business ( email )

1420 Austin Bluffs Parkway
Colorado Springs, CO 80933-7150
United States
1-719-255-5153 (Phone)

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