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The value of deposit insurance in the presence of interest rate and credit risk

Anderson, Ronald W. and Cakici, Nusret (1999) The value of deposit insurance in the presence of interest rate and credit risk. Financial Markets, Institutions and Instruments, 8 (5). pp. 45-62. ISSN 0963-8008

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Abstract

In this paper we employ the theory of the term structure of interest rates and the pricing of interest contingent contracts to determine the fair value of insurance for depository institutions. The balance sheet of a bank is taken to consist of long and short positions in various fixed income securities. Deposit insurance for the bank is a put option on the value of the assets. The value of deposits, assets, the implied exercise price of the put and the value of the put are all determined simultaneously as part of the same valuation solution. The approach is developed initially for a single-state term structure. It is extended to incorporate credit risk on bank assets. The most important policy implication is that for a bank whose assets are longer term than its liabilities and whose borrowers are not excessively leveraged the properly calculated, risk-adjusted deposit insurance premia are increasing functions of the level of interest rates. Sensitivity analyses also treat such factors as the bank's deposit to asset ratio, duration gap, interest volatility, the volatility of assets backing the bank loans, and the bank's borrowers’ debt to equity ratio.

Item Type: Article
Official URL: http://dx.doi.org/10.1111/1468-0416.00032
Additional Information: © 1999 New York Salomon Center
Library of Congress subject classification: H Social Sciences > HG Finance
Journal of Economic Literature Classification System: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General
G - Financial Economics > G2 - Financial Institutions and Services > G22 - Insurance; Insurance Companies
G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
Sets: Departments > Finance
Collections > Economists Online
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Date Deposited: 30 Nov 2012 13:44
URL: http://eprints.lse.ac.uk/47578/

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