"Estimating the Probability of Financial Distress in European Markets: Prediction Models and Empirical Applications"

Statistical default forecast models have been thoroughly described in the literature; however, most of these empirical studies fail to include appropriate performance valuation tests of these methodologies. This work analyses the main operating features of a base model, i.e. Altman’s Z-score, measuring its performance as a tool for forecasting insolvency in the current European market and compares its results with alternative bankruptcy prediction models. The assessment is conducted by testing the performance of the base model over a four-year time span (2006-2009) and by analyzing 165 companies listed in the UK, German, Spanish, Italian and Portuguese stock market. Forty years after Altman’s model first application, the largest companies in several European markets – such as those included in this paper – have grown to a point that makes them comparable to those in the US market (upon which the model was initially based). Hence, the underlying research question leads us to the analysis of the performance of the initial model if applied to the current European scenario. Results of the analysis show a number of differences among average Z-Scores across industries. If we also take into account the fact that there is no actual evidence of defaults among European listed companies that can be directly compared to those experienced by the US market during the same observation period, we can draw the conclusion that the implied similarity between European and US markets is not perfect.