Modelling failure rates with machine‐learning models: Evidence from a panel of UK firms

Abstract

AbstractIn this study, we investigate the ability of machine‐learning techniques to predict firm failures and we compare them against alternatives. Using data on business and financial risks of UK firms over 1994–2019, we document that machine‐learning models are systematically more accurate than a discrete hazard benchmark. We conclude that the random forest model outperforms other models in failure prediction. In addition, we show that the improved predictive power of the random forest model relative to its counterparts persists when we consider extreme economic events as well as firm and industry heterogeneity. Finally, we find that financial factors affect failure probabilities.