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Estimating Fair Premium Rates for Deposit Insurance Using Option Pricing Theory: An Empirical Study of Japanese Banks

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  • Oda, Nobuyuki

    (Bank of Japan)

Abstract

This paper utilizes option pricing theory to analyze bank stock prices as one method of estimating fair variable deposit insurance premium rates in accordance with individual bank default risk, and conducts empirical analyses using Japanese data. The purpose of the analyses is to discuss the framework of public organs' delegate monitoring of bank management. One of the functions of the deposit insurance system is such monitoring. The present system in the United States incorporates the subjective judgment of a bank supervisor combined with certain objective criteria for setting premium rates. There is a need to analyze the types of methodologies that might be viewed as options for adoption in Japan. To determine whether setting premium rates based on stock price information is a valid and stable approach, comparative analysis is conducted on the results of trial calculations utilizing this method versus other bank management indexes (credit ratings, etc.), and case analyses are carried out on failed banks. The conclusion is that while this method does involve a certain valuation error, it is an effective means of identifying banks with bad conditions. Moreover, the results confirm that by making adjustments for the changes in market expectations regarding the forbearance of the supervisory authorities, the accuracy of the estimates can be improved. Finally, this paper considers the impact on bank management that could be expected if this method were actually adopted.

Suggested Citation

  • Oda, Nobuyuki, 1999. "Estimating Fair Premium Rates for Deposit Insurance Using Option Pricing Theory: An Empirical Study of Japanese Banks," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 17(1), pages 133-170, May.
    • Handle: RePEc:ime:imemes:v:17:y:1999:i:1:p:133-170
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    File URL: https://www.imes.boj.or.jp/research/papers/english/me17-1-5.pdf
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    References listed on IDEAS

    as
    1. Chan, Yuk-Shee & Greenbaum, Stuart I & Thakor, Anjan V, 1992. "Is Fairly Priced Deposit Insurance Possible?," Journal of Finance, American Finance Association, vol. 47(1), pages 227-245, March.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    3. Richard Cantor & Kevin Cole & Frank Packer, 1997. "Split ratings and the pricing of credit risk," Research Paper 9711, Federal Reserve Bank of New York.
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    Cited by:

    1. Yumi Saita & Toshitaka Sekine, 2001. "Sectoral Credit Shifts in Japan: Causes and Consequences of Their Decline in the 1990s," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
    2. Kariastanto, Bayu, 2011. "Blanket guarantee, deposit insurance, and risk-shifting incentive: evidence from Indonesia," MPRA Paper 35557, University Library of Munich, Germany.
    3. Sekine, Toshitaka & Kobayashi, Keiichiro & Saita, Yumi, 2003. "Forbearance Lending: The Case of Japanese Firms," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 21(2), pages 69-92, August.
    4. Nagahata, Takashi & Sekine, Toshitaka, 2005. "Firm investment, monetary transmission and balance-sheet problems in Japan: an investigation using micro data," Japan and the World Economy, Elsevier, vol. 17(3), pages 345-369, August.
    5. Takashi Nagahata & Toshitaka Sekine, 2002. "The Effects of Monetary Policy on Firm Investment after the Collapse of the Asset Price Bubble: An Investigation Using Japanese Micro Data," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.

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    More about this item

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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