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The Diamond–Dybvig model is an influential model of bank runs and related financial crises. The model shows how banks' mix of illiquid assets (such as business or mortgage loans) and liquid liabilities (deposits which may be withdrawn at any time) may give rise to self-fulfilling panics among depositors.
One of the earliest and most influential models of liquidity crisis and bank runs was given by Diamond and Dybvig in 1983. The Diamond–Dybvig model demonstrates how financial intermediation by banks, performed by accepting assets that are inherently illiquid and offering liabilities which are much more liquid (offer a smoother pattern of returns), can make banks vulnerable to a bank run.
Diamond is best known for his work on financial crises and bank runs, particularly the influential Diamond–Dybvig model published in 1983 and the Diamond model of delegated monitoring published in 1984. [5] In 2016, he was awarded the CME Group-MSRI Prize in Innovative Quantitative Applications. [6]
In a 1983 paper, Diamond and Dybvig explored the banks’ key role as intermediary between savers and borrowers. They also found that banks are vulnerable: If savers fear their bank is in danger ...
Dybvig was awarded the 2022 Nobel Memorial Prize in Economic Sciences, jointly with Diamond and Ben Bernanke, "for research on banks and financial crises". [ 7 ] [ 8 ] Dybvig and Diamond wrote “Bank Runs, Deposit Insurance, and Liquidity” in 1983, in which they first introduced their mathematical model describing the vulnerability of banks ...
Diamond and Dybvig developed an influential model to explain why bank runs occur and why banks issue deposits that are more liquid than their assets. According to the model, the bank acts as an intermediary between borrowers who prefer long-maturity loans and depositors who prefer liquid accounts.
In the standard Diamond-Dybvig model, financial systems are vulnerable to a financial crisis in the form of a bank run due to the inherent nature of banking. Banks serve as intermediaries between depositors and borrowers. Depositors want immediate access to their deposits, while borrowers are not able to pay on demand.
While Cass and Shell's 1983 paper [1] defined the term sunspot in the context of general equilibrium, their use of the term sunspot (a term originally used in astronomy) alludes to the earlier econometric work of William Stanley Jevons, who explored the correlation between the degree of sunspot activity and the price of corn. [10]