A General Martingale Approach to Measuring and Valuing the Risk to the FDIC Deposit Insurance Funds

This paper presents a general methodology for measuring and valuing the risk of the FDIC deposit insurance funds using the martingale valuation approach. The FDIC insurance funds capitalize a portfolio of insurance policies, each issued against the deposits of an individual commercial bank. To evaluate this portfolio, our methodology evaluates each individual bank’s insurance policy and aggregates to obtain the risk of the entire portfolio. Our methodology includes the four relevant risks: interest rate, credit, deposit growth, and loss. To adequately model these four correlated risks, a multi-dimensional system is formulated. The risk measurement and valuation results are based on Monte Carlo simulation. The resulting methodology is flexible and easily modified to incorporate extensions and generalizations.