The pricing of deposit insurance in the presence of systematic risk

Shih-Cheng Lee, Chien-Ting Lin and Ming-Shann Tsai

Journal of Banking & Finance, 2015, vol. 51, issue C, 1-11

Abstract: Based on the Merton (1977) put option framework, we develop a deposit insurance pricing model that incorporates asset correlations, a measurement for the systematic risk of a bank, to account for the risk of joint bank failures. Estimates from our model suggest that actuarially fair risk-based deposit insurance that considers only individual bank failure risk is underpriced, leaving insurance providers exposed to net losses. Our estimates also capture the size premium where big banks are priced with higher deposit insurance than small banks. This result is particularly relevant to the current regulatory concerns on big banks that are too-big-to-fail. Above all, our approach provides a unifying framework for integrating risk-based deposit insurance with risk-based Basel capital requirements.

Keywords: Deposit insurance; Systematic risk; Asset correlation; Bank size (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:51:y:2015:i:c:p:1-11

DOI: 10.1016/j.jbankfin.2014.10.012

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