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On flexibility, capital structure, and investment decisions for the insured bank

  • Peter Ritchken
  • James Thomson
  • Ray DeGennaro
  • Anlong Li

Most models of deposit insurance assume that the volatility of a bank's assets is exogenously provided. Although this framework allows the impact of volatility on bankruptcy costs and deposit insurance subsidies to be explored, it is static and does not incorporate the fact that equityholders can respond to market events by adjusting previous investment and leverage decisions. This paper presents a dynamic model of a bank that allows for such behavior. The flexibility of being able to respond dynamically to market information has value to equityholders. The impact and value of this flexibility option are explored under a regime in which flat-rate deposit insurance is provided.

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File URL: http://www.clevelandfed.org/research/Workpaper/1991/wp9110.pdf
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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 9110.

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Date of creation: 1991
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Handle: RePEc:fip:fedcwp:9110
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  1. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
  2. Mark D. Flood, 1990. "On the use of option pricing models to analyze deposit insurance," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 19-35.
  3. Triantis, Alexander J & Hodder, James E, 1990. " Valuing Flexibility as a Complex Option," Journal of Finance, American Finance Association, vol. 45(2), pages 549-65, June.
  4. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  5. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
  6. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
  7. Edward J. Kane, 1985. "The Gathering Crisis in Federal Deposit Insurance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262611856, June.
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