Abstract
With the record high leverage across all segments of the (global) economy, default prediction has never been more important. The excess cash illusion created in the context of COVID-19 may disappear just as quickly as the pandemic entered our world in 2020. In this paper, instead of using any scoring device to discriminate between healthy companies and potential defaulters, we model default probability using a doubly stochastic Poisson process. Our paper is unique in that it uses a large dataset of non-public companies with low-quality reporting standards and very patchy data. We believe this is the first attempt to apply the Duffie–Duan formulation to emerging markets at such a scale. Our results are comparable, if not more robust, than those obtained for public companies in developed countries. The out-of-sample accuracy ratios range from 85% to 76%, one and three years prior to default, respectively. What we lose in (data) quality, we regain in (data) quantity; the power of our tests benefits from the size of the sample: 15,122 non-financial companies from 2007 to 2017, unique in this research area. Our results are also robust to model specification (with different macro and company-specific covariates used) and statistically significant at the 1% level.
Highlights
We demonstrate that the Duffie–Duan model successfully describes a default process for public companies from developed countries with well-functioning capital markets, but is successful in the context of privately owned equity markets with frequently patchy, low-quality data, operating in an emerging market characterized by lower transparency and governance standards (Aluchna et al 2019)
Remembering the objective of this paper is to show the applicability of the doubly stochastic Poisson model to a large dataset of low-quality corporate data from emerging markets, we are less preoccupied with the optimal selection of the state variables
The ratios analyzed are those used in the state variables model, i.e., liquidity, profitability, leverage, rotation, and size, all represented by two indices
Summary
In the world ravaged by the pandemic, with a fragile macro-economic outlook, low interest rates, and record high leverage, any academic research on bankruptcy is welcome. As the authors of this paper, we are neither professionally prepared nor interested in the debate on the degree of macro fragility or the effectiveness of the unprecedented stimulus packages adopted worldwide. Mentioning the unparalleled global leverage positions or the global health crisis, we merely acknowledge the emergence of the almost unmatched global uncertainty. In contrast to more optimistic views, exemplified by the stock exchange postCOVID-19 valuations, we believe the uncertainty is the only certain thing around us these days. Understanding the process of going down (in these circumstances) seems to us more than critical. Throughout this paper, bankruptcy and default are used interchangeably
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