Predicting bank bankruptcy – the case of AIG

Update 1. There is a post at MarketBeat devoted to AIG : AIG Shares: Still Not Worth Anything. In general it supports our model with a negative estimate of the share price. The case is getting more and more exiting ...

In the previous post on bankruptcy, we have described the evolution of share prices for the Colonial Bank (CNB) and the CIT Group (CIT). It was shown that CNB sank below the edge of bankruptcy. (All share prices are retrieved from YahooFinance.) Here we investigate the case of AIG. It has been bailed out. Not considering political, economic and financial aftermaths of such a bankruptcy we focus on the prediction by our 3-C model: a share price, sp(t), is described with the following empirical function:

sp(t) = A*CPI1(t+t1) + B*CPI2(t+t2) + C*(t-2000) + D (1)

where CPI1 and CPI2 are defining CPI components; t is the calendar time; A, B, C, and D are empirically determined coefficients. Because prices for good and services can lag or lead relevant share prices the time lags t1 and t2 are introduced. Both time lags can be positive or negative. In our model, we test all possible lags between 0 and +13 months. So, we chose the best from 34*33*14*14 ~ 200,000 possible models, with two extra degrees of freedom introduced by linear and free terms.

The full set includes 34 CPI components, which are tested as predictors for each share price. Among these components are major expenditure categories: the headline CPI (C), the core CPI, i.e. the headline CPI less food and energy (CC), food and beverages (F), housing (H), apparel (A), transportation (T), medical care (M), recreation (R), education (ED), communication (CO), and other goods and services (O). All components used in the model are not seasonally adjusted ones and retrieved from the Bureau of Labor Statistics.
When applied to AIG time series between July 2003 and August 2009, the 3-C model (1) for AIG is as follows:

AIG(t) = -89.29*F(t) – 08.31*FB (t-13) + 1031*(t-2000) + 32666 (2)

, where t is the calendar time, F(t) is the (not seasonally adjusted consumer price) index for food and beverages and FB(t-13) in the index of food without beverages leading AIG(t) by 13 months.
Figure 1 compares the stock price predicted according (2) with the observed one. There are two dives of the predicted price below zero – March and August 2009, the latter being of -$123. With standard deviation of $102, the predicted price in August likely hints at unresolved problems with AIG. However, the negative price might also result from the uncertainty in F and FB measurements.
We will continue tracking AIG stock price and reporting our predictions.


Figure 1. Comparison of the observed and predicted AIG’s share price. The latter is obtained using (2).