The use of the option pricing model to determine the actuarially fair premium for deposit insurance indicates that the cost of the insurance should rely on both the asset quality and level of leverage of the DI.

Question

Quizplus · Accepted Answer

The option pricing model takes into account the probability of default and the potential losses to determine the fair premium for deposit insurance. Therefore, the cost of insurance should depend on the riskiness of the DI's assets (asset quality) and the extent to which it relies on debt (leverage).

The Use of the Option Pricing Model to Determine the Actuarially