A Critique of Bankruptcy/Prediction Recovery Models
Michael C. I. Nwogugu
Applied Mathematics & Computation, 2006
Purpose: The purposes of this article are: (a) to evaluate and critique models of bankruptcy/recovery risk; and (b) to identify relevant elements of bankruptcy prediction and recovery prediction models.
Design/Methodology/Approach: The author critiques existing academic work on bankruptcy risk, recovery risk, decision making.
Findings: (a) All existing bankruptcy preiction and recovery prediction models are inaccurate; b) the models were developed using highly questionable methods and data, and are impractical; (c) risk and decision making are better quantified and modeled using a mix of situation-specific dynamic, quantitative, and qualitative factors; (d) bankruptcy models and recovery models do not incorporate the many psychological, legal, liquidity, knowledge, and price-dynamic factors inherent in capital markets, financial distress and asset prices, and thus, are not useful and accurate in many asset markets, particularly those outside the U.S. and in emerging market countries.
Research Limitations/Implications: Areas for further research include: (a) development of dynamic bankruptcy/recovery prediction models that incorporate asset-market psychology, ramifications of bankruptcy laws/rules, knowledge differences among market participants, and psychology.
Practical Implications: (a) bankrucpty/recovery analysis and Decision making are multi-criteria processes that typically require some processing of information, and thus cannot be defined accurately by rigid quantitative models; (b) existing bankruptcy prediction and recovery prediction (PROBIT, LOGIT, MDA, Neural nets, etc.) are inaccurate - many international banks, bankruptcy judges, central banks, government agencies, and financial institutions use these models for risk management, capital allocation, portfolio management, and investments, and thus the international financial system may be compromised.
Originality/Value: The critiques, ideas, and new theories in the article were all developed by the author. The issues discussed in the article are relevant to government regulators, banks, bankruptcy judges, companies, management science/operations research professionals, etc.
Number of Pages in PDF File: 19
Keywords: bankruptcy, decision making, risk, complexity
Date posted: December 5, 2005