The pricing of deposit insurance in the presence of systematic risk |
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| Institution: | 1. College of Management, Innovation Center for Big Data and Digital Convergence, Yuan Ze University, Chung-Li, Taiwan;2. School of Accounting, Economics, and Finance, Deakin University, Burwood, Victoria, Australia;3. Department of Finance, National University of Kaohsiung, Kaohsiung, Taiwan;1. Department of Economics, University of Haifa, Haifa 31905, Israel;2. Research Department, Federal Reserve Bank Boston, 600 Atlantic Avenue, Boston, MA 02210, USA;1. School of Finance, Nankai University, 38 Tongyan Road, Jinnan District, Tianjin 300350, China;2. Department of Finance, National Kaohsiung First University of Science and Technology, Kaohsiung, Taiwan;3. Risk and Insurance Research Center, College of Commerce, National Chengchi University, Taiwan;4. Department of Statistics and Actuarial Science, University of Waterloo, 200 University Avenue West, Waterloo N2L 3G1, ON, Canada;1. University of Liège, HEC – Management School, Belgium;2. EDHEC Business School, Lille-Nice, France;3. Haute Ecole Fr. Ferrer, Brussels, Belgium;4. Maastricht University, School of Business and Economics, Maastricht, The Netherlands;5. Gambit Financial Solutions, Belgium;1. Business School, Korea University, Seoul, Republic of Korea;2. Graduate School of Finance, Korea Advanced Institute of Science and Technology (KAIST), Seoul, Republic of Korea;3. Institute of Financial Analysis, University of Neuchatel, Neuchatel, Switzerland |
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| 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. |
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| Keywords: | Deposit insurance Systematic risk Asset correlation Bank size |
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