Levy Processes and the Financial Crisis: Can We Design a More Effective Deposit Protection?
Jessica Cariboni1, Sara Maccaferri1,2, Wim Schoutens2
1European Commission - Joint Research Centre, Ispra (VA), Italy; 2Department of Mathematics, K.U.Leuven, Leuven, Belgium

Levy processes have been applied in various financial settings to overcome the main shortcomings of the Gaussian distribution, since they allow for fat tails and jumps. In the present paper we propose to use Levy processes to simulate the distribution of losses deriving from bank failures.

The application of Levy processes is expected to provide successful results to this aim since bank failures are unexpected, rare events.

We propose to use the simulated distribution of losses to design an effective Deposit Guarantee Schemes (DGS). DGS are financial institutions whose main aim is to provide a safety net for depositors so that, if a credit institution fails, they will be able to recover their bank deposits up to a certain limit. During the recent global financial crisis, DGS were brought at the centre of the political and financial debate, especially due to the fact that the DGS in the European Union Member States resulted in most of the cases incapable to react to the financial crisis, especially due to the lack of funds set aside. By simulating banks' default and the corresponding losses, our model allows defining a target level for the funds to be collected be the scheme in order to promptly and effectively respond to financial crisis and protect the citizens.

The proposed approach is applied to a sample of Italian banks.

Keywords: Levy processes; Deposit insurance

Biography: Born in 1984, she graduated in 2008 in Mathematical Engineering (curriculum in Financial Mathematics and Statistics) at Politecnico di Milano, Italy. In 2010 she obtained a grant by the European Commission and she is currently a PhD student in financial modelling at the Katholieke Universiteit of Leuven, Belgium. Since 2009, she has been working for the Econometrics and Applied Statistics Unit of the European Commission Joint Research Centre.