Fuzzy Logic in Financial Management

Fuzzy logic has been widely used in machinery, robotics, and industrial engineering. This chapter introduces the use of fuzzy logic for the needs of financial management. The process of globalization has led to the emergence of a complex network of relationships in the business environment. In a free market economy, this means increased complexity and uncertainty of factors affecting the financial standing of entities. Nowadays many phenomena in finance and economics are fuzzy, but are treated as if they were crisp. In this chapter two such financial research problems are analyzed. The first concerns the issue of consumer credit scoring, while the second the forecasting of the financial situation of firms in short and medium periods (one year and two years forecasts). Predicting both business and consumer bankruptcy, is imprecise and ambiguous. The failure process is affected by many internal and external factors that cannot be precisely and unambiguously defined. Also, the mere allegation that a company or an individual consumer is at risk of bankruptcy must be considered imprecise, and in fact rarely in economic reality are there firms/persons that can be considered as 100% bankrupt. It is difficult to accurately determine the degree of bankruptcy threat using traditional statistical methods such as multivariate discriminant analysis. When the value of the discriminant function is less than the threshold value, we find that a company is at risk of bankruptcy. With the use of fuzzy logic vague and ambiguous concepts can be defined, such as "high risk of bankruptcy" or "low risk of bankruptcy". The presented models are the result of the chapter author’s ten years of experience on this issue. They can be used not only for forecasting the level of risk of bankruptcy but also for determining the degree of positive financial standing of the analyzed entity (a company or consumer) – for example, such as “outstanding solvency” or “average solvency” etc. The global financial crisis that began in mid-2008 caused the number of companies in danger of bankruptcy to significantly increase around the world. Furthermore, the highly globalized environment has caused the economies of countries to deteriorate too (for example: such countries as Greece or Iceland risking bankruptcy; the decrease of the USA’s credit rating from AAA to AA+ by rating agencies for the first time in history), which directly and indirectly influences the financial situation of both companies and consumers. Therefore, analysts are no longer faced with the dilemma of whether to predict the financial standing of entities (enterprises, consumers, or even countries), but what forecasting method to use in order to minimize forecast errors.