Journal of Risk

Risk.net

Forecasting corporate defaults in the German stock market

Richard Lennart Mertens, Thorsten Poddig and Christian Fieberg

  • The Campbell et al. (2008) failure score outperforms other default risk models.
  • The Altman (1968) Z-Score shows very low discriminatory power.
  • The Merton (1974) distance-to-default is miscalibrated.
  • Differences between these models are likely to affect the profitability of lenders.

In this paper, we estimate and test several default risk models using new and unique data on corporate defaults in the German stock market. While defaults were extremely rare events in the 1990s, they have been a characteristic feature of the German stock market since the early 2000s. Here, we apply the structural Merton distance to default (DD) as well as several reduced-form models. A variety of performance evaluation tools, including receiver-operating-characteristics analysis, calibration tests and a loan market simulation, are used, which suggest that the Campbell, Hilscher and Szilagyi failure score outperforms the other models. Although the performance evaluation metrics show that the failure score performs slightly worse in our case than for US data, we recommend it as a benchmark default risk model for research as well as the industry. We show that lenders who apply this model are more profitable than those who apply others. Moreover, we warn of several pitfalls associated with the Altman z-score and the DD. The former has very weak discriminatory power and the latter is severely miscalibrated.

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to Risk.net? View our subscription options

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here