Predicting Bank Failures Using a Simple Dynamic Hazard Model
by Rebel A. Cole of DePaul University, and
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.
Keywords: bank, bank failure, early warning system, failure prediction, forecasting, hazard model, time-varying covariates.