An Empirical Comparison of Early Warning Bank Failure Models Using McNemar's Test

32 Pages Posted: 30 Jan 2019

See all articles by Rebel A. Cole

Rebel A. Cole

Florida Atlantic University

Jon Taylor

Florida Atlantic University - Finance

Date Written: December 15, 2018

Abstract

In a field of study as robust as bank failure, many researchers investigate the same question: What factors increase the likelihood of bank failure? Models built to answer this question are highly accurate and span decades of research. What has yet to be answered is whether the models are different. This paper uses McNemar’s Test on out of sample predictions to show with statistical significance that discordant errors (where one model is correct and the other is wrong) provide the answer. This paper uses Cole and White (2012) as a baseline model to which two other papers (Martin (1977) and DeYoung and Torna (2013)) are compared. We find that the Martin model is highly accurate on its own, but in a different way than Cole and White. Additionally, we find that the DeYoung and Torna model is statistically different from Cole and White, but an interesting trade-off in accuracy occurs. Finally, we compare a hybrid model which relies on variables of interest from all three papers and find that the new approach is dissimilar and more accurate. The testing methodology is useful for all predictive models which benefit from a vast source of prior research and serves as a tool for researchers to determine if their new predictive model is different in a meaningful way, which may help future researchers decide how best to contribute to their field of research.

Keywords: bank, bank failure, CAMELS, FDIC, McNemar’s Test, early warning system

JEL Classification: G17, G21, G28

Suggested Citation

Cole, Rebel A. and Taylor, Jon, An Empirical Comparison of Early Warning Bank Failure Models Using McNemar's Test (December 15, 2018). Available at SSRN: https://ssrn.com/abstract=3318303 or http://dx.doi.org/10.2139/ssrn.3318303

Rebel A. Cole

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 (Contact Author)

Florida Atlantic University - Finance ( email )

777 Glades Rd
Boca Raton, FL 33431
United States

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