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Predicting Bank Failures Using a Simple Dynamic Hazard Model

by Rebel A. Cole of DePaul University, and
Qiongbing Wu of the University of Newcastle

April 13, 2009

Abstract: We use a simple dynamic hazard model with time-varying covariates to develop a bank failure early warning model, and then test the out-of-sample forecasting accuracy of this model relative to a simple one-period probit model, such as is used by U.S. banking regulators. By incorporating time-varying covariates, our model enables us to utilize macroeconomic variables, which cannot be incorporated into in a one-period model. We find that our model significantly outperforms the simple probit model with and without the macroeconomic variables. The improvement in accuracy comes both from the time-series bank specific variables and from the time-series macro-economic variables.

JEL Classification: G17, G21, G28.

Keywords: bank, bank failure, early warning system, failure prediction, forecasting, hazard model, time-varying covariates.

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