Sound Deposit Insurance Pricing Using a Machine Learning Approach

Hirbod Assa, Mostafa Pouralizadeh and Abdolrahim Badamchizadeh
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Hirbod Assa: Mathematical Sciences Building, University of Liverpool, Liverpool L69 7ZL, UK
Mostafa Pouralizadeh: Department of Statistics, Faculty of Mathematical Science and Computer, Allameh Tabataba’i University, Tehran 1489684511, Iran
Abdolrahim Badamchizadeh: Department of Statistics, Faculty of Mathematical Science and Computer, Allameh Tabataba’i University, Tehran 1489684511, Iran

Risks, 2019, vol. 7, issue 2, 1-18

Abstract: While the main conceptual issue related to deposit insurances is the moral hazard risk, the main technical issue is inaccurate calibration of the implied volatility. This issue can raise the risk of generating an arbitrage. In this paper, first, we discuss that by imposing the no-moral-hazard risk, the removal of arbitrage is equivalent to removing the static arbitrage. Then, we propose a simple quadratic model to parameterize implied volatility and remove the static arbitrage. The process of removing the static risk is as follows: Using a machine learning approach with a regularized cost function, we update the parameters in such a way that butterfly arbitrage is ruled out and also implementing a calibration method, we make some conditions on the parameters of each time slice to rule out calendar spread arbitrage. Therefore, eliminating the effects of both butterfly and calendar spread arbitrage make the implied volatility surface free of static arbitrage.

Keywords: deposit insurance; implied volatility; static arbitrage; parameterization; machine learning; calibration (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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