Predicting defaults of highly-levered firms with an adapted Altman model

Abstract

The purpose of this paper is to analyse whether applying Altman's model, with specific adjustments to highly levered firms, can reliably predict bankruptcies one quarter, one year, and two years in advance. Our focus on highly levered firms is motivated by leverage-driven theories of financial crises, where highly levered firms are the early defaulters once the expansionary phase of the business cycle turns into a recessionary phase. We find high predictability of defaults of firms in the Real-estate and Holding-companies sectors in Israel one year before the recent crisis.