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Forecasting Corporate Bankruptcy: Applying Feature Selection Techniques to the Pre- and Post-Global Financial Crisis Environments
By Parker Levi
I investigate the use of feature selection techniques to forecast corporate bankruptcy in the years before, during and after the global financial crisis. Feature selection is the process of selecting a subset of relevant features for use in model construction. While other empirical bankruptcy studies apply similar techniques, I focus specifically on the effect of the 2007-2009 global financial crisis. I conclude that the set of bankruptcy predictors shifts from accounting variables before the financial crisis to market variables during and after the financial crisis for one-year-ahead forecasts. These findings provide insight into the development of stricter lending standards in the financial markets that occurred as a result of the crisis. My analysis applies the Least Absolute Shrinkage and Selection Operator (LASSO) method as a variable selection technique and Principal Components Analysis (PCA) as a dimensionality reduction technique. In comparing each of these methods, I conclude that LASSO outperforms PCA in terms of prediction accuracy and offers more interpretable results.
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Advisors: Professor Andrew Patton, Professor Michelle Connolly | JEL Codes: G1, G01, G33