Get 20M+ Full-Text Papers For Less Than $1.50/day. Start a 14-Day Trial for You or Your Team.

Learn More →

Systematic risk and deposit insurance pricing

Systematic risk and deposit insurance pricing The purpose of this paper is to alleviate the moral hazard problem created by deposit insurance and therefore develop a deposit insurance pricing model explicitly considering systematic risk.Design/methodology/approachUsing the market model, the authors introduce the systematic risk component consisting of market risk and beta risk. A closed-form solution for the authors’ pricing model is derived based on the option pricing framework.FindingsCompared with the authors’, the pricing model that ignores systematic risk underestimates deposit insurance premium, and cannot cover the excessive loss created by systematic risk. To examine the effect of the systematic risk component on the deposit insurance premiums estimated by the authors’ model, this paper also provides empirical evidence from China by regression analysis. The results demonstrate that, in addition to the individual failure risk, the systematic risk component is properly priced and explicitly reflected in the authors’ model.Research limitations/implicationsMore risk factors such as liquidity risk should be introduced in the pricing of deposit insurance.Practical implicationsDeposit insurance premiums estimated by the authors’ model can alleviate the moral hazard problem that banks have an incentive to take on excessive systematic risk, because substantial higher insurance premiums would be charged in doing so.Originality/valueApplying the option pricing theory and market model, this paper develops a deposit insurance pricing model with explicit consideration of systematic risk. The systematic risk component contains not only the market volatility but also the sensitivity of market risk. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png China Finance Review International Emerald Publishing

Systematic risk and deposit insurance pricing

Zhang, Yaojie; Shi, Benshan
China Finance Review International , Volume 7 (4): 17 – Oct 11, 2017
Download PDF
17 pages

Loading next page...
 
/lp/emerald-publishing/systematic-risk-and-deposit-insurance-pricing-owYZuw5MWR
Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
2044-1398
DOI
10.1108/cfri-12-2016-0133
Publisher site
See Article on Publisher Site

Abstract

The purpose of this paper is to alleviate the moral hazard problem created by deposit insurance and therefore develop a deposit insurance pricing model explicitly considering systematic risk.Design/methodology/approachUsing the market model, the authors introduce the systematic risk component consisting of market risk and beta risk. A closed-form solution for the authors’ pricing model is derived based on the option pricing framework.FindingsCompared with the authors’, the pricing model that ignores systematic risk underestimates deposit insurance premium, and cannot cover the excessive loss created by systematic risk. To examine the effect of the systematic risk component on the deposit insurance premiums estimated by the authors’ model, this paper also provides empirical evidence from China by regression analysis. The results demonstrate that, in addition to the individual failure risk, the systematic risk component is properly priced and explicitly reflected in the authors’ model.Research limitations/implicationsMore risk factors such as liquidity risk should be introduced in the pricing of deposit insurance.Practical implicationsDeposit insurance premiums estimated by the authors’ model can alleviate the moral hazard problem that banks have an incentive to take on excessive systematic risk, because substantial higher insurance premiums would be charged in doing so.Originality/valueApplying the option pricing theory and market model, this paper develops a deposit insurance pricing model with explicit consideration of systematic risk. The systematic risk component contains not only the market volatility but also the sensitivity of market risk.

Journal

China Finance Review International – Emerald Publishing

Published: Oct 11, 2017

Keywords: Option pricing; Deposit insurance; Market model; Systematic risk; G21; G22; G28

References

  • A theory of systemic risk and design of prudential bank regulation
    Acharya, V.V.
  • Too many to fail – an analysis of time-inconsistency in bank closure policies
    Acharya, V.V.; Yorulmazer, T.
  • Systemic risk and deposit insurance premiums
    Acharya, V.V.; Santos, J.; Yorulmazer, T.
  • Bank regulation and supervision: what works best?
    Barth, J.R.; Caprio, G.; Levine, R.
  • The pricing of options and corporate liabilities
    Black, F.; Scholes, M.
  • On persistence in mutual fund performance
    Carhart, M.M.
  • The cross-section of expected trading activity
    Chordia, T.; Huh, S.-W.; Subrahmanyam, A.
  • Does deposit insurance increase banking system stability? An empirical investigation
    Demirgüç-Kunt, A.; Detragiache, E.
  • Deposit insurance around the globe: where does it work?
    Demirgüç-Kunt, A.; Kane, E.J.
  • Deposit insurance around the world: a comprehensive analysis and database
    Demirgüç-Kunt, A.; Kane, E.; Laeven, L.
  • Forbearance and pricing deposit insurance in a multiperiod framework
    Duan, J.-C.; Yu, M.-T.
  • Capital standard, forbearance and deposit insurance pricing under GARCH
    Duan, J.-C.; Yu, M.-T.
  • Deposit insurance and bank interest rate risk: pricing and regulatory implications
    Duan, J.-C.; Moreau, A.F.; Sealey, C.
  • Market pricing of deposit insurance
    Duffie, D.; Jarrow, R.; Purnanandam, A.; Yang, W.
  • Common risk factors in the returns on stocks and bonds
    Fama, E.F.; French, K.R.
  • Stock prices and volume
    Gallant, A.R.; Rossi, P.E.; Tauchen, G.
  • The pricing of deposit insurance considering bankruptcy costs and closure policies
    Hwang, D.-Y.; Shie, F.-S.; Wang, K.; Lin, J.-C.
  • Deposit insurance and bank risk-taking: evidence from internal loan ratings
    Ioannidou, V.P.; Penas, M.F.
  • Bank governance, regulation and risk taking
    Laeven, L.; Levine, R.
  • The pricing of deposit insurance in the presence of systematic risk
    Lee, S.-C.; Lin, C.-T.; Tsai, M.-S.
  • Redefinition of the KMV model’s optimal default point based on genetic algorithms‐evidence from Taiwan
    Lee, W.-C.
  • The valuation of FDIC deposit insurance using option-pricing estimates
    Marcus, A.J.; Shaked, I.
  • An analytic derivation of the cost of deposit insurance and loan guarantees an application of modern option pricing theory
    Merton, R.C.
  • On the cost of deposit insurance when there are surveillance costs
    Merton, R.C.
  • Deposit insurance, bank regulation, and financial system risks
    Pennacchi, G.
  • Estimating standard errors in finance panel data sets: comparing approaches
    Petersen, M.A.
  • Pricing risk-adjusted deposit insurance: an option-based model
    Ronn, E.I.; Verma, A.K.
  • A simplified model for portfolio analysis
    Sharpe, W.F.
  • Deposit insurance and forbearance under moral hazard
    So, J.; Wei, J.Z.
  • A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity
    White, H.
  • Non-tradable shares pricing and optimal default point based on hybrid KMV models: Evidence from China
    Zhang, Y.; Shi, B.