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Visit emeraldpublishing. Answers to the most commonly asked questions here. To read the full version of this content please select one of the options below:. For example, an important but often overlooked confounding factor is the endogenous response of depositors. However, double liability also reduces the market discipline of depositors, who benefit from the enhanced safety of their deposits.
Our model analyzes the effect of liability structure on excessive risk taking in the presence of potential deposit withdrawals i. If depositors monitor their banks and react to negative information by withdrawing funds, banks are incentivized to avoid excessive risks. But depositors have fewer incentives to respond to negative information if deposits are protected from losses. The model predicts that although double liability unambiguously makes deposits stickier when negative information is revealed i.
To our knowledge, this tradeoff between the direct effect of reduced risk taking and the indirect effect of weaker market discipline has not been explored in the literature.
However, obtaining credible estimates of this effect is challenging because differences in local economic conditions, regulation, supervision, and other unobservable characteristics all pose threats to inference.
To overcome these issues, we use a novel identification strategy based on the unique regulatory environment in the United States prior to the Great Depression.
Ideally, we would like to compare banks that simultaneously face identical regulatory requirements e. To achieve this, our identification strategy is to compare national banks with state Federal Reserve member banks Fed member in neighboring states within the same Federal Reserve district in this case, the Second District but with different liability rules.
While all national banks operated under double liability throughout the s and early s, state banks operated under the liability rules of the state. Specifically, our identification strategy exploits the fact that state banks operated under double liability in New York but under single limited liability in New Jersey.
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List of Partners vendors. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways Moral hazard, essentially, is risk-taking. Article Sources.
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