Paper #130

Title:

Fair pricing of deposit insurance. Is it possible? Yes. Is it desirable? No

Authors:

Xavier Freixas and Jean Charles Rochet

Date:

January 1995 (Revised: June 1995)

Abstract:

This note elaborates on a recent article by Chan, Greenbaum and Thakor (1992) who contend that fairly priced deposit insurance is incompatible with free competition in the banking sector, in the presence of adverse selection. We show here that at soon as one introduces a real economic motivation from private banks to manage the deposits from the public, then fairly priced deposit insurance becomes possible. However, we also show that such a fairly priced insurance is never desirable, precisely because of adverse selection. We compute the characteristics of the optimal premium schedule, which trades off between the cost of adverse selection and the cost of ``unfair competition ''.

Area of Research:

Finance and Accounting

Published in:

Research in Economics, 52, 3, (1998), pp. 217-232

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