Time-varying Z-score measures for bank insolvency risk: best practice

Abstract

We evaluate several alternative approaches to the construction of time-varying Z-scores as bank insolvency risk measures. Focusing on US and European banks during the financial crisis of 2007-2008, we carry out comparisons of the different measures considered using a range of alternative testing procedures. For both US and European data, Z-scores computed with the exponentially weighted moments method are shown to be preferable to those computed with the more commonly used moving moments approach. Generally, or if only simple moving moments are used, Z-scores computed with current values of the capital-asset ratio are recommended.

Keywords: Z-score; bank; insolvency risk; risk measure

JEL Classification: G21, G28