Saturday, March 1, 2014

Review of Bankruptcy, Credit Risk, and High Yield Junk Bonds by Edward Altman

Bankruptcy, Credit Risk, and High Yield Junk Bonds is a collection of academic papers by NYU professor Edward Altman, including many that were written with coauthors.

The book starts with a paper revisiting his famous Z-Score bankruptcy prediction model from 1968. The Type II error of the Z-Score model (classifying a firm as failing when it does NOT fail) is surprisingly high, until you understand that the model was created to minimize Type I error. Short sellers beware as this means you cannot rely on the Z-Score as a good candidate.

Chapter 6 is “Managing a Return to Financial Health” by Altman and James La Fleur, who used the Z-score model to create a recovery strategy for GTI Corporation during the 1970s.

Funny one star review on Amazon:

"Reading this guy's work is a real testimony to the staying power generated by doing something first. His 1967 paper on bankruptcy was the first to estimate a multivariate default prediction model. THAT'S 35 YEARS AGO."
It's still a good desk reference for statistics on default rates, recovery rates, and so forth. Plus, understanding what was state of the art 46 years ago is worthwhile. You have to understand how you got somewhere to understand where you are.

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