Designing sound deposit insurances
Designing sound deposit insurances
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 cases are two-layer policies.
226-242
Assa, Hirbod
c1c2d621-80c4-497c-8500-0ac5ef58bdc9
Okhrati, Ramin
e8e0b289-be8c-4e73-aea5-c9835190a54a
1 January 2018
Assa, Hirbod
c1c2d621-80c4-497c-8500-0ac5ef58bdc9
Okhrati, Ramin
e8e0b289-be8c-4e73-aea5-c9835190a54a
Assa, Hirbod and Okhrati, Ramin
(2018)
Designing sound deposit insurances.
Journal of Computational and Applied Mathematics, 327, .
(doi:10.1016/j.cam.2017.05.043).
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 cases are two-layer policies.
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Banking-10-9-16.pdf
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Submitted date: 2016
Accepted/In Press date: 1 June 2017
e-pub ahead of print date: 21 June 2017
Published date: 1 January 2018
Organisations:
Faculty of Social, Human and Mathematical Sciences
Identifiers
Local EPrints ID: 404750
URI: http://eprints.soton.ac.uk/id/eprint/404750
ISSN: 0377-0427
PURE UUID: cfb4e1b3-2795-428f-ad64-73f282011e83
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Date deposited: 17 Jan 2017 10:19
Last modified: 15 Mar 2024 06:14
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Author:
Hirbod Assa
Author:
Ramin Okhrati
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