Access to deposit insurance, insolvency rules and the stock returns of financial institutions

Abstract

This paper analyzes how access to deposit insurance affects the common stock returns of financial institutions during periods of financial distress. During periods of distress the definition of insolvency used by insuring agencies may be modified to avoid a substantial number of bank failures. These modifications can increase the value of future deposit guarantees and affect the behavior of stock returns of banks and S&Ls. This hypothesis is examined using S&L data for the 1976 through 1983 period. Modification of insolvency rules applied to S&Ls appears to have reduced significantly the co-movement of S&L stock returns with S&L portfolio holdings.