This paper develops an option-based pricing model to study the optimal bank interest margin determination with hidden action under deposit insurance. This model shows that the optimal bank interest margin reacts negatively to an increase in the deposit insurance premium, and the bank, given a constant risk-adjusted deposit insurance has an incentive to gamble for resurrection when the bank operates on a relatively less elastic portion of its loan demand curve. The findings demonstrate the important links between optimal interest margins and market discipline.
Relation:
International Journal of Management 22(1), pp.71-78
