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Designing sound deposit insurances

Assa, H; Okhrati, R; (2018) Designing sound deposit insurances. Journal of Computational and Applied Mathematics , 327 pp. 226-242. 10.1016/j.cam.2017.05.043. Green open access

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Abstract

Deposit insurances were blamed for encouraging the excessive risk taking behavior during the 2008 financial crisis. The main reason for this destructive behavior was “moral hazard risk”, usually caused by inappropriate insurance policies. While this concept is known and well-studied for ordinary insurance contracts, yet needs to be further studied for insurances on financial positions. In this paper, we set up a simple theoretical framework for a bank that buys an insurance policy to protect its position against market losses. The main objective is to find the optimal insurance contract that does not produce the risk of moral hazard, while keeping the bank’s position solvent. In a general setup we observe that an optimal policy is a multi-layer policy. In particular, we obtain a close form solution for the optimal insurance contracts when a bank measures its risk by either Value at Risk or Conditional Value at Risk. We show the optimal solutions for these two case are two-layer policies.

Type: Article
Title: Designing sound deposit insurances
Open access status: An open access version is available from UCL Discovery
DOI: 10.1016/j.cam.2017.05.043
Publisher version: https://doi.org/10.1016/j.cam.2017.05.043
Language: English
Additional information: This version is the author accepted manuscript. For information on re-use, please refer to the publisher’s terms and conditions.
Keywords: Deposit insurance, solvency, risk measure and premium, Black-Scholes model, moral hazard, VaR, CVaR, stop-loss
UCL classification: UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL BEAMS
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science > Dept of Civil, Environ and Geomatic Eng
URI: https://discovery.ucl.ac.uk/id/eprint/10081495
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