Forecasting Corporate Failure: Understanding Statistical and Theoretical Approaches to Bankruptcy Prediction

AIRA Journal, Vol. 29, No. 1

10 Pages Posted: 28 Jul 2017

See all articles by Andrew Wong

Andrew Wong

Independent

Konstantin A. Danilov, CFA

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Analysis Group

Date Written: July 25, 2015

Abstract

The application of bankruptcy prediction models in litigation to evaluate whether a company was in default, or about to default, at a particular time can be helpful in a wide range of contexts when used appropriately, according to a recent AIRA Journal article authored by Managing Principal Andrew Wong and Manager Konstantin Danilov. In "Forecasting Corporate Failure: Understanding Statistical and Theoretical Approaches to Bankruptcy Prediction" (Vol. 29, No. 1, 2015), the authors describe two categories of bankruptcy prediction models -- statistical and theoretical -- and examine their use in litigation. "Statistical models attempt to identify the most common symptoms exhibited by bankrupt companies, and then use this information to estimate the likelihood that a particular firm will go bankrupt in the future," the authors explain. "Conversely, theoretical models predict bankruptcy by attempting to identify and gauge the factors responsible for the causes of bankruptcy."

Noting that understanding "the strengths and weaknesses of these approaches is helpful when deciding which particular prediction model to apply in a bankruptcy setting," the authors describe the history of each model, explore their predictive performance and limitations, and examine several case examples. The authors conclude that, because of "differences in rationale, effectiveness, and applicability, each model is uniquely suited" to determine the likelihood that a company will go bankrupt. "As such, the applicability and validity of any approach will always depend on the context and the details of the particular case."

Keywords: bankruptcy prediction, insolvency

Suggested Citation

Wong, Andrew and Danilov, Konstantin A., Forecasting Corporate Failure: Understanding Statistical and Theoretical Approaches to Bankruptcy Prediction (July 25, 2015). AIRA Journal, Vol. 29, No. 1. Available at SSRN: https://ssrn.com/abstract=3008641

Andrew Wong

Independent

No Address Available

Konstantin A. Danilov (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

Analysis Group ( email )

111 Huntington Avenue, Tenth Floor
Boston, MA 02199
United States

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