Universität Bonn

Department of Economics

Nicola Limodio - Bocconi

Deposit Insurance and Portfolio Allocation

Abstract

This paper examines the effects of deposit insurance (DI) on the household portfolio allocation between bank deposits and risky assets. Our theoretical framework shows that limited DI creates a kink in the capital allocation line, prompting depositors to bunch at the DI threshold and increase equity investments. Using a natural experiment in India and monthly individual-level data, we first confirm depositor bunching at the DI threshold. Employing a bunching-in-difference approach, we then show that DI expansion shifts portfolios from equity and mutual funds to deposits, producing temporary asset pricing effects. We document that this shift from equity to deposits is driven by an unmet demand for safe assets, indicating the crucial role of DI in limiting the supply of safe assets. Bunchers invest more in safer equity of state-owned firms and liquidate them after DI expansion with transient asset pricing implications for these stocks. Finally, by integrating our model with the data, we estimate the depositor-implied probability of bank failure and evaluate the welfare implications of DI-induced portfolio reallocation. Our welfare analysis suggests that although DI expansion can increase welfare, this improvement is limited by the increase in moral hazard after DI expansion.

Additional information:

  • Speaker: Nicola Limodio 
  • Time: Wednesday, 28.05.2025, 14:45 - 16:00
  • Location: Faculty Lounge, Room 0.036
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  • Organizer: Finance Group
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