The purpose of this paper is to put forward an innovative approach for reducing the variation between Type I and Type II errors in the context of ratio‐based modeling of corporate collapse, without compromising the accuracy of the predictive model. Its contribution to the literature lies in resolving the problematic trade‐off between predictive accuracy and variations between the two types of errors.
The methodological approach in this paper – called MCCCRA – utilizes a novel multi‐classification matrix based on a combination of correlation and regression analysis, with the former being subject to optimisation criteria. In order to ascertain its accuracy in signaling collapse, MCCCRA is empirically tested against multiple discriminant analysis (MDA).
Based on a data sample of 899 US publicly listed companies, the empirical results indicate that in addition to a high level of accuracy in signaling collapse, MCCCRA generates lower variability between Type I and Type II errors when compared to MDA.
Although correlation and regression analysis are long‐standing statistical tools, the optimisation constraints that are applied to the correlations are unique. Moreover, the multi‐classification matrix is a first in signaling collapse. By providing economic insight into more stable financial modeling, these innovations make an original contribution to the literature.
