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Journal of Banking & Finance Vol. 33 No. 10 2009

The pricing of deposit insurance considering bankruptcy costs and closure policies

Dar-Yeh Hwang1; Fu-Shuen Shie2; Kehluh Wang3; Jung-Chu Lin4

1 National Taiwan University · 2 Department of Finance, National Tai-Chung Institute of Technology, 129 Sanmin Road, Section 3, Taichung, Taiwan, ROC · 3 National Yang Ming Chiao Tung University · 4 Takming University of Science and Technology

Abstract

The paper aims to study the pricing issue of deposit insurance with explicit consideration of bankruptcy costs and closure policies. Full coverage from deposit insurance is imposed by many regulators to stabilize the banking system in the current financial crisis, despite of the potential moral hazard problems. We argue that bankruptcy cost is an important factor in pricing deposit insurance, especially when the insured institution is insolvent. Applying the isomorphic relationship between deposit insurance and put option, we first derive a closed-form solution for the pricing model with bankruptcy costs and closure policies. Then, we modify the barrier option approach to price the deposit insurance in which the bankruptcy cost is set as a function of asset return volatility and more realistic closure policies considering possible forbearance can be accounted for. The properties of the models are supported by numerical simulations and are consistent with the risk-based pricing scheme.

DOI
10.1016/j.jbankfin.2009.04.013
Volume
33
Issue
10
Pages
1909-1919
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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