Nonstationary Z-Score measures

Abstract

In this work we develop advanced techniques for measuring bank insolvency risk. More specifically, we contribute to the existing body of research on the Z-Score. We develop bias reduction strategies for state-of-the-art Z-Score measures in the literature. We introduce novel estimators whose aim is to effectively capture nonstationary returns; for these estimators, as well as for existing ones in the literature, we discuss analytical confidence regions. We exploit moment-based error measures to assess the effectiveness of these estimators. We carry out an extensive empirical study that contrasts state-of-the-art estimators to our novel ones on over ten thousand banks. Finally, we contrast results obtained by using Z-score estimators against business news on the banking sector obtained from Factiva. Our work has important implications for researchers and practitioners. First, accounting for the degree of nonstationarity in returns yields a more accurate quantification of the degree of solvency. Second, our measure allows researchers to factor in the degree of uncertainty in the estimation due to the availability of data while estimating the overall risk of bank insolvency.JEL-Classification: C20, C60, G21

Bank Capital and Risk in Europe and Central Asia Ten Years after the Crisis

“…Our measure of bank risk is the z-score, which is calculated as the sum of average bank returns on assets (net income divided by total assets) and the bank equity to assets ratio, scaled by the standard deviation of return on assets over a four-year rolling window. A higher z-score indicates lower bank risk (Mare et al, 2017).…”

Capital and Liquidity Risks and Financial Stability: Pre, During and Post Financial Crisis Between Islamic and Conventional Banks in GCC Countries, in the Light of Oil Prices Decline

“…Čihák & Hesse, 2008;Martin Čihák & Hesse, 2010;Fu et al, 2014;Ghassan et al, 2013;Ghosh, 2014). Nevertheless, the recent study of Clark et al (2018) who have used a new approach of the Z-score formula (as shown in 1 and the appendix of summary of all variables" measures, data resources and related references are shown) which is produced by Mare et al (2017). Mare et al (2017) criticized all previous approaches of Z-score index as they are deemed to be less effective.…”

“…Nevertheless, the recent study of Clark et al (2018) who have used a new approach of the Z-score formula (as shown in 1 and the appendix of summary of all variables" measures, data resources and related references are shown) which is produced by Mare et al (2017). Mare et al (2017) criticized all previous approaches of Z-score index as they are deemed to be less effective. Against this backdrop, this paper will follow Clark et al (2018), who adopted the following formula:…”

Does Financial Instability of Conventional Banks Affect Financial Stability of Islamic Banks in GCC Countries?

“…Čihák & Hesse, 2008;Martin Čihák & Hesse, 2010;Fu et al, 2014;Ghassan et al, 2013;Ghosh, 2014). Nevertheless, the recent study of Clark et al (2018) who have used a new approach of the Z-score formula (as shown in 1), which is produced by Mare et al (2017). Mare et al (2017) criticized all previous approaches of Z-score index as they are deemed to be less effective.…”

“…Nevertheless, the recent study of Clark et al (2018) who have used a new approach of the Z-score formula (as shown in 1), which is produced by Mare et al (2017). Mare et al (2017) criticized all previous approaches of Z-score index as they are deemed to be less effective. Against this backdrop, this paper will follow Clark et al (2018), who adopted the following formula:…”