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Bank diversification: laws and fallacies of large numbers

  • Joseph G. Haubrich

Conventional wisdom on bank diversification confuses risk with failure. This article clarifies the distinction and shows how increasing bank size may increase bank risk, even though it lessens the probability of failure and lowers the expected loss. The key result is an application of Samuelson's "fallacy of large numbers."

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File URL: http://www.clevelandfed.org/research/review/1998/98-q2-haubrich.pdf
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Article provided by Federal Reserve Bank of Cleveland in its journal Economic Review.

Volume (Year): (1998)
Issue (Month): Q II ()
Pages: 2-9

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Handle: RePEc:fip:fedcer:y:1998:i:qii:p:2-9:n:v.34no.2
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  1. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  2. Boyd, John H. & Runkle, David E., 1993. "Size and performance of banking firms : Testing the predictions of theory," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 47-67, February.
  3. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-60, August.
  4. Haubrich, Joseph G., 1990. "Nonmonetary effects of financial crises : Lessons from the great depression in Canada," Journal of Monetary Economics, Elsevier, vol. 25(2), pages 223-252, March.
  5. James B. Thomson, 1986. "The use of market information in pricing deposit insurance," Working Paper 8609, Federal Reserve Bank of Cleveland.
  6. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc.
  7. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January.
  8. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June.
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