A Hybrid Model for Business Failure Prediction – Utilization of Particle Swarm Optimization and Support Vector Machines

Bankruptcy has long been an important topic in finance and accounting research. Recent headline bankruptcies have included Enron, Fannie Mae, Freddie Mac, Washington Mutual, Merrill Lynch, and Lehman Brothers. These bankruptcies and their financial fallout have become a serious public concern due to huge influence these companies play in the real economy. Many researchers began investigating bankruptcy predictions back in the early 1970s. However, until recently, most research used prediction models based on traditional statistics. In recent years, however, newly-developed data mining techniques have been applied to various fields, including performance prediction systems. This research applies particle swarm optimization (PSO) to obtain suitable parameter settings for a support vector machine (SVM) model and to select a subset of beneficial features without reducing the classification accuracy rate. Experiments were conducted on an initial sample of 80 electronic companies listed on the Taiwan Stock Exchange Corporation (TSEC). This paper makes four critical contributions: (1) The results indicate the business cycle factor mainly affects financial prediction performance and has a greater influence than financial ratios. (2) The closer we get to the actual occurrence of financial distress, the higher the accuracy obtained both with and without feature selection under the business cycle approach. For example, PSO-SVM without feature selection provides 89.37% average correct cross-validation for two quarters prior to the occurrence of financial distress. (3) Our empirical results show that PSO integrated with SVM provides better classification accuracy than the Grid search, and genetic algorithm (GA) with SVM approaches for companies as normal or under threat. (4) The PSO-SVM model also provides better prediction accuracy than do the Grid-SVM, GA-SVM, SVM, SOM, and SVR-SOM approaches for seven well-known UCI datasets. Therefore, this paper proposes that the PSOSVM approach could be a more suitable method for predicting potential financial distress.