Deposit Insurance with Changing Volatility: An Application of Exotic Options

OFOR Working Paper Number 93-02

Posted: 5 Sep 1994

See all articles by Phelim P. Boyle

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics; University of Waterloo

Inmoo Lee

KAIST College of Business

Multiple version iconThere are 2 versions of this paper

Abstract

Merton pioneered the application of the option pricing framework to the pricing of deposit insurance for financial institutions. Most applications in the deposit insurance area assume that the volatility of the assets of the bank is exogenous whereas is may be more realistic to assume it is endogenous. We develop a simple model that represents first steps in this direction. It is assumed that the volatility of the bank's assets changes or can be changed when the assets first hit a certain level. We permit the volatility to be selected in an optimal fashion at this barrier and develop expressions for the shareholders' equity and the deposit insurance premium. This analysis uses generalizations of particular types of barrier options known as down and out and down and in options. Numerical examples are developed to illustrate the properties of the model.

JEL Classification: G13, G21, G28

Suggested Citation

Boyle, Phelim P. and Lee, Inmoo, Deposit Insurance with Changing Volatility: An Application of Exotic Options. OFOR Working Paper Number 93-02, Available at SSRN: https://ssrn.com/abstract=5496

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519 884 1970 (Phone)
519 888 1015 (Fax)

University of Waterloo

Waterloo, Ontario N2L 3G1
Canada

Inmoo Lee (Contact Author)

KAIST College of Business ( email )

85 Hoegiro Dongdaemun-Gu
Seoul 02455
Korea, Republic of (South Korea)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
909
PlumX Metrics