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Predicting corporate bankruptcy using the framework of Leland-Toft: Evidence from US

Predicting corporate bankruptcy using the framework of Leland-Toft: Evidence from US
Predicting corporate bankruptcy using the framework of Leland-Toft: Evidence from US
In this paper, we evaluate an alternative approach for bankruptcy prediction that measures the financial healthiness of firms that have coupon-paying debts. The approach is based on the framework of Leland, H. and Toft, K.B. [Optimal capital structure, endogenous bankruptcy and the term structure of credit spreads. J. Financ., 1996, 51, 987–1019], which is an extension of a widely-used model; the Black–Scholes–Merton model. Using U.S. public firms between 1995 and 2014, we show that the Leland-Toft approach is more powerful than Black–Scholes–Merton in a variety of tests. Moreover, extending popular but also contemporary corporate bankruptcy models with the probability of bankruptcy derived from the Leland-Toft model, such as Altman, E. [Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. J. Financ., 1968, 23, 589–609], Ohlson, J.A. [Financial ratios and the probabilistic prediction of bankruptcy. J. Account. Res., 1980, 18, 109–131] and Campbell, J. Y., Hilscher, J. and Szilagyi, J. [In search of distress risk. J. Financ., 2008, 63, 2899–2939], yields models with improved performance. One of our tests, for example, shows that banks using these extended models, achieve superior economic performance relative to other banks. Our results are consistent under a comprehensive out-of-sample framework.
Bank performance, Corporate bankruptcy, Leland and Toft, Predictive ability
1469-7688
329-346
Charalambous, Christakis
a8a7538e-a1a4-4212-bf73-3125c1e41fac
Martzoukos, Spiros
a15d7302-0583-41f4-9ae4-41109211c9e0
Taoushianis, Zenon
5c536511-1155-4a5b-8249-0a944572b7fc
Charalambous, Christakis
a8a7538e-a1a4-4212-bf73-3125c1e41fac
Martzoukos, Spiros
a15d7302-0583-41f4-9ae4-41109211c9e0
Taoushianis, Zenon
5c536511-1155-4a5b-8249-0a944572b7fc

Charalambous, Christakis, Martzoukos, Spiros and Taoushianis, Zenon (2020) Predicting corporate bankruptcy using the framework of Leland-Toft: Evidence from US. Quantitative Finance, 20 (2), 329-346. (doi:10.1080/14697688.2019.1667519).

Record type: Article

Abstract

In this paper, we evaluate an alternative approach for bankruptcy prediction that measures the financial healthiness of firms that have coupon-paying debts. The approach is based on the framework of Leland, H. and Toft, K.B. [Optimal capital structure, endogenous bankruptcy and the term structure of credit spreads. J. Financ., 1996, 51, 987–1019], which is an extension of a widely-used model; the Black–Scholes–Merton model. Using U.S. public firms between 1995 and 2014, we show that the Leland-Toft approach is more powerful than Black–Scholes–Merton in a variety of tests. Moreover, extending popular but also contemporary corporate bankruptcy models with the probability of bankruptcy derived from the Leland-Toft model, such as Altman, E. [Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. J. Financ., 1968, 23, 589–609], Ohlson, J.A. [Financial ratios and the probabilistic prediction of bankruptcy. J. Account. Res., 1980, 18, 109–131] and Campbell, J. Y., Hilscher, J. and Szilagyi, J. [In search of distress risk. J. Financ., 2008, 63, 2899–2939], yields models with improved performance. One of our tests, for example, shows that banks using these extended models, achieve superior economic performance relative to other banks. Our results are consistent under a comprehensive out-of-sample framework.

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SSRN-id3316105 - Accepted Manuscript
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Accepted/In Press date: 12 July 2019
e-pub ahead of print date: 31 October 2019
Published date: 1 February 2020
Additional Information: Publisher Copyright: © 2019, © 2019 Informa UK Limited, trading as Taylor & Francis Group.
Keywords: Bank performance, Corporate bankruptcy, Leland and Toft, Predictive ability

Identifiers

Local EPrints ID: 434597
URI: http://eprints.soton.ac.uk/id/eprint/434597
ISSN: 1469-7688
PURE UUID: a72cc180-1257-4efa-9e02-25325d1ae7e3
ORCID for Zenon Taoushianis: ORCID iD orcid.org/0000-0003-2002-6040

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Date deposited: 02 Oct 2019 16:30
Last modified: 29 Jul 2022 04:01

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Contributors

Author: Christakis Charalambous
Author: Spiros Martzoukos

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