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Working Paper

On Flexibility, Capital Structure, and Investment Decisions for the Insured Bank

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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 equity holders 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.
07.01.1991ISSN 2573-7953 WP 91-10DOI 10.26509/frbc-wp-199110

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Ritchken, Peter, James B. Thomson, Ramon DeGennaro, and Anlong Li. 1991. “On Flexibility, Capital Structure, and Investment Decisions for the Insured Bank.” Federal Reserve Bank of Cleveland, Working Paper No. 91-10. https://doi.org/10.26509/frbc-wp-199110