To avoid the moral hazard problem, our preferred risk index ought to tell us that if one financial firm is twice as risky as another, the former will pay FDIC insurance premiums that are twice as high as what the latter will have to pay.

Question

Quizplus · Accepted Answer

The moral hazard problem arises when parties insulated from risk behave differently than they would if they were fully exposed to the risk. By adjusting FDIC insurance premiums based on the risk level of financial firms, it creates an incentive for these firms to engage in less risky behavior, as their insurance premiums would directly reflect their risk level. This approach helps mitigate the moral hazard problem by aligning the cost of insurance with the risk being insured.

To Avoid the Moral Hazard Problem, Our Preferred Risk Index