Date October 10, 2022
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Brown Class of 1975 graduate wins Nobel Prize in Economic Sciences

Douglas W. Diamond, a University of Chicago scholar who earned a bachelor’s degree in economics from Brown, was recognized for research on banks and financial crises.

STOCKHOLM, SWEDEN — Douglas W. Diamond, a University of Chicago scholar who earned a bachelor’s degree in economics from Brown University in 1975, is one of three recipients of the 2022 Nobel Prize in Economic Sciences, the Royal Swedish Academy of Sciences announced on Monday, Oct. 10.

Diamond will share the prize with Ben S. Bernanke, former chair of the Federal Reserve and now a fellow at the Brookings Institution, and Philip H. Dybvig of Washington University in St. Louis.

The academy honored Diamond, a professor of finance at the University of Chicago Booth School of Business, and the two other economists for improving “our understanding of the role of banks in the economy, particularly during financial crises.” His pioneering research has changed the way people view banks and laid the groundwork for how central bankers, regulators, policymakers and academics approach modern finance.

“An important finding in their research is why avoiding bank collapses is vital,” the Swedish Academy’s announcement said. “Modern banking research clarifies why we have banks, how to make them less vulnerable in crises and how bank collapses exacerbate financial crises. The foundations of this research were laid by Ben Bernanke, Douglas Diamond and Philip Dybvig in the early 1980s.”

The scholars’ analyses have been of great practical importance in regulating financial markets and dealing with financial crises, the academy added: “The actions taken by central banks and financial regulators around the world in confronting two recent major crises — the Great Recession and the economic downturn that was generated by the COVID-19 pandemic — were in large part motivated by the laureates’ research.”

In a virtual news conference hosted by the Swedish Academy, Diamond spoke about how best to avoid and respond to financial crises: “The best advice is to be prepared for making sure that your part of the banking sector is both perceived to be healthy and to stay healthy and respond in a measured and transparent way to changes in monetary policy. The key insight that Phil Dybvig and I tried to make in our paper on bank runs is: It’s not so much about banks; it’s not so much about creating money. It’s about issuing short-term and liquid liabilities — like deposits in the case of a bank or shares in the case of a mutual fund — which are much more liquid than the underlying assets that they hold.”

As a Nobel laureate, Diamond will receive a gold medal, a diploma and approximately $300,000 — a third of the roughly $900,000 economics prize.

Diamond is known for his research into financial intermediaries, financial crises and liquidity. His research focus for the past four decades has been to explain what banks do, why they do it and the consequences of these arrangements. His earliest research explained how the economic role of banks generated an essential link between the properties of their assets and the form of their liabilities. In “Financial Intermediation and Delegated Monitoring,” a paper based on his Ph.D. dissertation published in the Review of Economic Studies in 1984, he showed how the bank’s special assets forced them to finance themselves with debt liabilities rather than equity and also led banks to diversify across many loans.

He and Dybvig later developed the Diamond-Dybvig model in “Bank Runs, Deposit Insurance and Liquidity,” published in the Journal of Political Economy in 1983. The Diamond-Dybvig model demonstrates how banks specializing in creating liquid liabilities (deposits) to fund illiquid assets (such as business loans) may be unstable and give rise to bank runs. It shows how banks’ special liabilities, combined with illiquid assets, explain the role of banks, why they may be unstable and why they may need a government safety net (such as deposit insurance) more than other borrowers.

The model has since been used to understand other run-like phenomena in markets during financial crises.

“Phil Dybvig and I had the idea when we did our research that it could have some impact on the way that central bankers and regulators around the world thought about the financial system, about banks, about deposit insurance stability,” Diamond said in a University of Chicago news story. “Given that those issues of stability in the financial system are still very important, I’m very happy this was acknowledged.”

Diamond is a research associate of the National Bureau of Economic Research and a visiting scholar at the Federal Reserve Bank of Richmond. He was president of the American Finance Association and the Western Finance Association, is a member of the National Academy of Sciences, and is a fellow of the Econometric Society, the American Academy of Arts and Sciences, and the American Finance Association. He joined Chicago Booth’s faculty in 1979.

Diamond has taught at Yale University and was a visiting professor at the MIT Sloan School of Management, the Hong Kong University of Science and Technology, and the University of Bonn. Diamond earned a bachelor’s degree in economics from Brown University in 1975. He earned master’s degrees in 1976 and 1977 and a Ph.D. in 1980 in economics, all from Yale University.

With reporting from the Royal Swedish Academy of Sciences and the University of Chicago.