Predicting Financial Distress in a High-Stress Financial World

Mardi | 2010-06-01

Adrian POP – Jérome COFFINET – Muriel TIESSET – Sébastien GALANTI

The current global crisis offers a unique opportunity to investigate the leadingproperties of market indicators in an increasingly stressed environment and their usefulnessfrom a banking supervision perspective. One pool of relevant information that hasbeen overlooked so far in the empirical literature is the market for bank’s exchange-tradedoption contracts. In this paper, we first extract early-warning indicators from the pricesof the most actively traded option contracts on financial firms’ equity. We then examineempirically their ability to predict financial distress by applying survival analysis techniquesto a sample of large US financial firms. We find that market indicators extractedfrom option prices significantly explain the survival time of troubled financial firms anddo a better job in predicting financial distress than other time-varying covariates typicallyincluded in bank failure models. Overall, both accounting information and option pricescontain useful information of subsequent financial problems and, more importantly, thecombination produce better forecasts in a high-stress financial world, full of doubts anduncertainties.