Public Economics and Policy Seminar - Nicola Limodio (Bocconi University)

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-indifference approach, we then show that DI expansion shifts portfolios from equity and mutual funds to deposits, producing temporary asset pricing effects. 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.