The cost of deposit insurance for privately held banks: A market comparable approach

Michael Falkenheim, George Pennacchi

Research output: Contribution to journalArticlepeer-review

Abstract

Previous empirical studies that use an option pricing model to estimate deposit insurance costs have been limited to banks that issue publicly traded securities: a bank's security prices are used to infer its risk characteristics. However, if deposit insurance costs are needed for privately held banks, as would be the case under a system of risk-based insurance premiums, then an alternative method is required. This paper presents a "market comparable" approach for valuing private banks' deposit insurance. The approach first uses information on public depository institutions to identify the statistical relationships between a bank's supervisory accounting data and its risk characteristics derived from equity market data. Second, it uses these relationships to predict the risk characteristics of a private depository institution based on its supervisory accounting data. This approach is applied to over 7000 private banks and thrifts to estimate their risk characteristics and their implied risk-neutral and physical probabilities of insolvency. For the vast majority of institutions, these risk characteristics and insolvency probabilities are within a reasonable range.

Original languageEnglish (US)
Pages (from-to)121-148
Number of pages28
JournalJournal of Financial Services Research
Volume24
Issue number2-3
DOIs
StatePublished - Jan 1 2003

Keywords

  • Deposit insurance
  • Market comparable valuation

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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