Chapter 15: Pricing Fair Deposit Insurance: Structural Model Approach

In this chapter, we propose the structural model in terms of the Stair Tree model and barrier option to evaluate the fair deposit insurance premium in accordance with the constraints of the deposit insurance contracts and the consideration of bankruptcy costs. First, we show that the deposit insurance model in Brockman and Turle (2003) is a special case of our model. Second, the simulation results suggest that insurers should adopt a forbearance policy instead of a strict policy for closure regulation to avoid losses from bankruptcy costs. An appropriate deposit insurance premium can alleviate potential moral hazard problems caused by a forbearance policy. Our simulation results can be used as reference in risk management for individual banks and for the Federal Deposit Insurance Corporation (FDIC).