Bankruptcy Forecasting Models and the Problem of Endogeneity. A Case of Malaysian Banking Industry

This study by investigating the relevant previous literature on bankruptcy forecasting models identified that accounting for endogeneity in bankruptcy forecasting models have been widely over-sighted, and using these models as it is may lead towards inconsistent results and biased precision in some contexts. Considering the sensitivity of bankruptcy forecasting issue, it is vital that the precision drawn about it should be unbiased and accurate. In line with that, this study established that retained earnings under variable X2 of the Altman’ (2000) model is endogenous to firm’s age in the perspective of Malaysian banking industry. Subsequently, this study sets an efficient instrumental variable for the identified endogenous variable in order to get accurate and unbiased bankruptcy forecasting results for Malaysian banking industry using Altman model. The analysis here is viable to draw the attention of researchers towards the relatively neglected, but very essential aspect in bankruptcy forecasting. This study may open avenues for researchers to consider endogeneity in the bankruptcy forecasting models and investigating the subsequent instrumental variables for it.