Douglas Diamond wins Nobel Prize for research on banks and financial crises

Economist becomes 97th scholar associated with the University of Chicago to receive Nobel Prize

Prof. Douglas W. Diamond of the University of Chicago has been awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022.

The Royal Swedish Academy of Sciences honored Diamond, the Merton H. Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business, and 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.

Diamond shared the prize with Ben Bernanke of the Brookings Institution and Philip Dybvig of Washington University in St. Louis.

“Professor Diamond has made extraordinary contributions to the field of economics and our collective understanding of the role financial institutions play in society, particularly in times of financial crises,” said University of Chicago President Paul Alivisatos. “This is a well-deserved recognition of his groundbreaking scholarship.”

Diamond is the 97th scholar associated with the University to receive a Nobel Prize, and the 33rd to receive the Nobel in economics. In addition to Diamond, seven current UChicago faculty members are Nobel laureates in economics: Prof. Michael Kremer (who won in 2019), Prof. Richard Thaler (2017), Profs. Eugene Fama and Lars Hansen (2013), Prof. Roger Myerson (2007), Prof. James Heckman (2000) and Prof. Robert E. Lucas Jr. (1995).

Diamond learned the news of his Nobel win in the early hours of Oct. 10. Though the call from Sweden was a surprise, he was saved from wondering if the call was a prank because he knew two of the Nobel committee members very well and recognized their voices. “I thought it was probably legit, but you never know—I have some friends with a good sense of humor,” he said. “[But] if someone could impersonate them as well as they did, they were better than most. So I figured out it was the real thing.” 

Transformative research with global impact

Diamond is considered a founder of modern banking theory. He is known for his research into financial intermediaries, financial crises and liquidity; his research agenda for the past 40 years has been to explain what banks do, why they do it and the consequences of these arrangements.

Introducing Diamond at a news conference held at UChicago’s David Rubenstein Forum, Chicago Booth Dean Madhav Rajan said: “His groundbreaking ideas literally created modern banking theory. His work and insights have had global impact, and truly transformed the way we think about banking.”

One of Diamond’s most influential works was the Diamond-Dybvig model, which he co-developed with Dybvig in “Bank Runs, Deposit Insurance, and Liquidity” in the Journal of Political Economy in 1983. 

The Diamond-Dybvig model clearly and concisely laid out the fundamental paradox for banks: They are repositories for consumers’ cash, but when banks make investments with that cash, it tends to tie up money so that it can’t be immediately liquidated. In normal times, this is a good way to create wealth, but it can lead to a crisis if everyone panics and tries to withdraw all their funds at the same time. “[The system] is very vulnerable to the fear of fear itself,” Diamond explained. 

To keep this from happening, it’s important to maintain government regulation and safety nets, such as providing deposit insurance, the theory says. 

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

“Phil [Dybvig] and I discussed how we should write this so that the average central banker who’s not an economic theorist can understand it,” Diamond said. “I think one reason why that paper had more influence than it would otherwise is the basic structure of what it has is quite simple.”

Speaking at the UChicago news conference, Alivisatos said he had read Diamond’s and Dybvig’s groundbreaking paper and immediately understood why it had been so widely recognized: “It’s a beautiful work of art.” 

The Nobel announcement also cited Diamond’s work on the function of banks as intermediaries between many savers and borrowers—pointing out their role in assessing borrowers’ creditworthiness and the likelihood of success of their investments, and in monitoring the health of current investments.

The majority of his career has been dedicated to financial stability, Diamond said. “So given that those issues of stability in the financial system are still very important, I’m very happy this was acknowledged.”

‘An amazing place’

Diamond joined Chicago Booth’s faculty in 1979.

“The University of Chicago has been an amazing place to keep trying to do one’s best research, year after year after year,” he said. His work was subject to detailed comments by his colleagues, including those in other specializations, he said: “It forced me to think clearly about what I was doing and whether it made any sense.” 

Diamond also cited working with students as a way to make sure his work, though theoretical, was useful to policymakers. “Having them question things turned out to be very useful as a value-add to figuring out how to do useful research,” he said.

“Diamond and Dybvig’s research has significantly altered economic policy and the practical way in which the financial system is regulated—for example, much of the regulatory response to the global financial crisis has been informed by their work,”  said Anil Kashyap, the Stevens Distinguished Service Professor of Economics and Finance at the University of Chicago Booth School of Business and a longtime colleague of Diamond’s. 

“This is really what the University, in so many ways, is all about,” Alivisatos said. “We’re here, in countless ways, to address some of the greatest challenges that face society.” 

Diamond’s other highly cited works include “Monitoring and Reputation: The Choice Between Bank Loans and Directly Placed Debt” in the Journal of Political Economy in 1991, and “Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking” in the Journal of Political Economy in 2001. The latter was co-written with Chicago Booth Prof. Raghuram G. Rajan, with whom Diamond has written a series of influential papers on banking and financial crises.

Diamond is associated faculty in the University of Chicago’s Kenneth C. Griffin Department of Economics, teaching in its doctoral program. He 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.

He is also a research associate of the National Bureau of Economic Research. He has served as 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.

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. 

He has been married to fellow economist Elizabeth Cammack Diamond, MBA'78, PhD'87, since 1982. They have two children.

Asked whether he thought the work should have received a Nobel Prize earlier, Diamond said no: “You don’t want to win it too young. It goes to your head.”