Diamond-Dybvig and Beyond: On the Instability of Banking

Chao Gu, Cyril Monnet, Ed Nosal and Randall Wright

No 2023-02, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: Are financial intermediaries—in particular, banks—inherently unstable or fragile, and if so, why? We address this question theoretically by analyzing whether model economies with financial intermediation are more prone than those without it to multiple, cyclic, or stochastic equilibria. We consider several formalizations: insurance-based banking, models with reputational considerations, those with fixed costs and delegated investment, and those where bank liabilities serve as payment instruments. Importantly for the issue at hand, in each case banking arrangements arise endogenously. While the economics and mathematics differ across specifications, they all predict that financial intermediation engenders instability in a precise sense.

Keywords: banking; financial intermediation; instability; volatility (search for similar items in EconPapers)
JEL-codes: D02 E02 E44 G21 (search for similar items in EconPapers)
Pages: 49
Date: 2023-02-13
New Economics Papers: this item is included in nep-des, nep-dge and nep-pay
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Citations: View citations in EconPapers (4)

Published in 2023

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Related works:
Journal Article: Diamond–Dybvig and beyond: On the instability of banking (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedawp:95902

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DOI: 10.29338/wp2023-02

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