FORBEARANCE AND VALUATION OF DEPOSIT INSURANCE AS A CALLABLE PUT

Previous research evaluating deposit insurance as a put option has ignored the ability of the deposit insurer (put writer) to control the timing of the put's exercise via closure decisions. We model deposit insurance as a callable put, i.e., a put option where the FDIC retains a valuable call provision. The value of deposit insurance subsidies can therefore be measured as the net difference between the put and call features of the insurance contract. Forbearance can be viewed as forfeiture by the deposit insurer of the value of its call component of the deposit insurance option.