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August 03, 2006

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dsquared

The z-score isn't a predictive model; it's a classification model. It classifies companies into high and low risk of financial distress. There is a big difference between this and prediction of financial distress and it does not surprise me that a measure which is developed for one purpose doesn't perform well at another. I think the author of the paper on z-scores is quite confused and hasn't really thought at all about the meaning of the statistical tools he's using.

btw, I can't quite agree that "common sense" says that stocks with poor profitability and shonky balance sheets would be expected to outperform.

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