I was born in Chicago in 1953. My maternal grandparents were Catholic. My grandmother, Ethel Elizabeth Houlehan Gunkel, was of Irish descent. She was a strong woman who lived to 100 and was lots of fun. My grandfather, Frederick Peter Gunkel, was of Austrian and German descent. He was the executive hog buyer for Oscar Mayer in Madison, Wisconsin, which insulated the Gunkel family from the Great Depression of the 1930s. In that period, the Gunkel family was able to help feed their neighbors with food from Oscar Mayer. My grandfather died in his 50s, and my grandmother became the matriarch of the Gunkel clan. My grandfather had told her to never sell her Oscar Mayer stock, almost her entire net worth, which violated all of investment portfolio theory. She never sold, but she did well when General Foods acquired Oscar Mayer in 1981.

My grandparents on my father’s side were Jewish. My grandfather, Harry Diamond, emigrated from Austria at age 14. He owned and managed a family rabbinical wine company in New York City, started by the family of my grandmother, Hattie Wirklich Diamond. The wine company went out of business during the Great Depression, and he never recovered emotionally. He died in 1944 at age 58. Hattie Diamond lived until age 84. She never forgave my father for not marrying a Jewish woman. I only met her a few times in my life.

My mother, Margaret Irene Gunkel Seehafer, was born in Madison, Wisconsin, one of four children. She married her college sweetheart, William Bleckwenn Jr., soon after she graduated from the University of Wisconsin, majoring in economics and psychology. He died of a brain aneurism in 1947, less than two years later. My mother subsequently earned a Master of Social Work degree from the University of Minnesota. She met my father, Leon Diamond, in Minneapolis, where they were married in 1952. They moved to Chicago. Their marriage ended in divorce before I was two years old.

My mother joined the PhD program in Social Service Administration at the University of Chicago while she was raising me as the only child of a single mother. She was very devoted and supportive. She always encouraged me even though I was a terrible student until high school. She told family members (but not me) that she would be happy if I improved sufficiently to graduate from junior college. We lived in the Hyde Park neighborhood near the University of Chicago until I was in eighth grade. My mom was close to her three siblings, and we spent holidays with them. I loved visiting my cousins, who made me feel like a sibling of theirs when we came.

My mother was a Democrat and involved in local and national politics, hosting events for campaigns to elect candidates such as John F. Kennedy. I heard more about politics and government policy than most seven-year-olds did. She later became quite interested in investing in mutual funds, and discussions with her before I was in high school may have helped develop my interest in economics (which only became my primary interest years later).

My mother did not finish her doctoral dissertation at the University of Chicago. She had a successful career as a social worker, eventually becoming the deputy director of the Illinois Department of Mental Health. In 1973, she moved back to Madison, Wisconsin and began teaching social work at the University of Wisconsin. She married an old friend from college, Gene F. Seehafer, in 1976. He passed away in 1996. My mom passed away in 2017.

My father grew up in the Bensonhurst neighborhood in Brooklyn, New York. He went to college in 1941 at the University of Louisville. He joined the navy in 1943 and became part of the V-12 Navy College Training Program to quickly get an MD and serve in the Navy during World War II. He was discharged in 1945, at the end of World War II. He completed his MD in 1946. After an internship at Kings County hospital in Brooklyn and serving as a general practitioner in Red Jacket, West Virginia, he became a resident in Obstetrics and Gynecology at the University of Minnesota in 1951. He (and my mother) moved to Chicago in 1952, where he became a resident in psychiatry at the University of Illinois Chicago, switching specialties in medicine. He had a successful career as a psychiatrist, both in private practice and academic medicine. He was on the faculty of Northwestern University, eventually as the head of residents’ training and inpatient programs at Northwestern University’s hospital. He retired in 1992 and passed away in 2022. My father lived in Chicago almost my entire life, and I saw him regularly as a child and as an adult. He remarried in 1962 and I have two brothers, Mark and Jason, from that marriage.

My Education

In high school, I became a better student, especially in science and mathematics courses. I attended a private school starting in eighth grade, The Latin School of Chicago. The Latin School changed dramatically while I was there, from a traditional and highly structured school to a progressive and innovative one. As a not very disciplined student in eighth grade, the traditional and structured school suited me well. Latin hired new young leaders from California, starting in my junior year. They brought in new courses and attitudes. By then, the less structured approach also suited me well, as I had become a more serious student. A course on US constitutional law expanded my interest in social science. This was followed by a seminar on capitalism. A main reading for the course was Capitalism and Freedom, by Milton Friedman. The following year, I helped teach the course by reading chapters from Paul Samuelson’s classic introductory textbook, Economics. The other students and I would read a chapter, and I would lead discussion. High school provided an introduction to very accessible books by two of the greatest living economists. Nonetheless, by the time I graduated, I wanted to become a molecular biologist. This was in part due to the influence of my biology teacher who arranged a one-student advanced second course in biology for me.

Brown University

I applied early decision to Brown University to study biological science. I enrolled in a biology course that I immediately found uninteresting. I decided to drop the course two weeks into my first semester. I found an intermediate microeconomics course that fit my schedule and had no prerequisites. Due to my background in high school, I felt that skipping introduction to economics was appropriate. The course was quite advanced, but not very mathematical. A more mathematical microeconomics course followed the next term, and I decided to switch my concentration to economics.  

A summer job in Chicago at A. G. Becker, after my first year in college, turned out to be related to my subsequent research interests. A. G. Becker was an investment bank that was developing a database for a product, the Commercial Paper Program Service. The project measured the full borrowing costs to firms for whom they had issued commercial paper. This was to allow Becker to show the borrowers how these costs compared to borrowing via bank loans on the same dates. My job was to collect the data (from paper confirmation slips) and find errors in the data. I also collected data on the costs of bank loans with similar maturities and issue dates. It did not use economics, but it did introduce me to the idea of the choice between bank loans and directly placed debt.

A budding interest in health economics led me to take a job during another summer with the state of Rhode Island House of Representatives Commission to Study Medical Malpractice Rates. I learned about the political economy of regulation, with competing interest groups and regulatory capture. I also became more aware of other non-economic issues involved in setting health policy. This is one reason that I subsequently switched to finance; it is an area that has fewer objectives that compete with attempts to resolve moral hazard and conflicts of interest.

In my senior year, I took a small undergraduate course taught by Jerome Stein on Milton Friedman and Anna Schwartz’s Monetary History of the United States. This taught me to think about the effects of monetary policy, while also learning many facts about inflation and economic fluctuations in the United States. Almost half of the course was devoted to the chapter on the great contraction of the 1930s. Friedman and Schwartz describe the bank failures of the period and ascribe much of it to the Federal Reserve’s unexpected unwillingness to serve as a lender of last resort. Bank failures and tight monetary policy led to a reduced supply of money and this led to a falling price level. They argued that this was the way that bank failures damaged the economy. It seemed to me at the time that bank failures would have other adverse effects on the real economy. In my final exam for the course, I argued that the bank failures would cause an inward shift in the Hicks-Hansen IS curve; there would be less real activity for a given rate of interest. I did not provide a mechanism for the shift. I only remembered this recently after looking at my old exam. My exam book from the course is the artifact that I gave to the Nobel Prize Museum.

Jerome Stein was a monetarist like Friedman, but he was a student of James Tobin, who was a Keynesian. He had the highest respect for both Friedman and Tobin. He encouraged me to go to Yale and try to work with Tobin. I also benefited from great graduate macroeconomics courses at Brown from Herschel Grossman and William Poole.

Yale University

I joined the PhD program in Economics at Yale in 1975. The ideas from the emerging field of finance showed up in the first-year macroeconomics courses. James Tobin emphasized financial markets and institutions in his research on monetary and fiscal policy. I soon met Martin Shubik, who was working on a theory of money and financial institutions. He pointed out many questions that competitive market general equilibrium theory could not address or would not provide a satisfactory prediction. Nothing could be more useful to someone looking for a topic to study. Shubik’s research used noncooperative game theory to model trade with money and price formation as a playable game. Banks were important in payments and the price formation mechanism. Although I never succeeded in adopting his methodology, I learned that one could use game theory to reexamine important applied issues in economics. I hoped to use game theory to model money and banking together.

James Tobin helped me get a job offer for the summer of 1976 from the Financial Institutions and Nation’s Economy (FINE) study. It was commissioned by the U.S. House of Representatives Banking Committee to propose reforms to regulation of banks. By the spring of that year, before I could begin work, the FINE commission was disbanded, supposedly due to pressure from lobbyists for the large banks. Professor Donald Hester, of the FINE commission and the University of Wisconsin, encouraged me to apply for a summer job at the Financial Studies section of the Federal Reserve Board of Governors. I learned both practical and conceptual aspects of banking at the Fed. Donald P. Tucker (formally on the faculty at the University of Chicago Economics department) hired me to fix a simulation model built to see what would happen to savings and loan associations if interest rates greatly increased. I tried to fix the old model, but I could not. Instead, I built a new one from scratch. Not too surprisingly, the savings and loans became market value insolvent from high interest rates, but it took a very long time for their book accounting capital to become negative. This was an accurate prediction of the future because they borrowed short-term to finance 30 year fixed-rate mortgages. I was then hired the next two summers to maintain the model, and also to examine the relative merits of introducing floating rate mortgages and long-term deposits to avoid the risk of insolvency. The Fed was an amazing place to learn from one’s colleagues. Sandy Grossman was on staff, while George Akerlof and John Boyd were visitors.

Peter Lloyd-Davies of the Financial Studies Section suggested that I take a course in Financial Economics, as that field addressed some of the questions I was working on. I returned to New Haven and learned that Yale did not have any such course. I found out that Harvard and Yale had an exchange program, and I took a great finance course from John Lintner at the Harvard Business School. I also read the reading lists of several other finance courses and the detailed class notes from Robert Merton’s course at MIT. I became a convert to financial economics. I decided to take my oral exams in the two fields of Finance and Monetary Economics. The director of graduate studies (William Parker, an economic historian) told me that I could not do both, because these were the same field. An intervention by James Tobin convinced him that these fields were distinct.

In my oral exams, one of my examiners in finance was Steve Ross, who had just been hired away from the University of Pennsylvania and would join the Yale faculty the following autumn. I had never met Steve, but I passed. I took a course from him that autumn and developed a much better understanding of finance. Steve brought the great students, Chester Spatt and Phil Dybvig, with him from Penn. I learned from them both.

My interests moved toward the effects of private information on financial markets and financial institutions. My first attempts at models were unsuccessful and complicated. Discussions with Steve helped me figure out what I was trying to do. Steve taught me how to build simpler applied models. For my first paper, he told me to take everything out of the model until it was not a model. Then, he suggested that I return one of the removed elements to the model and see what I got. I did that, and the model became simple to solve and interpret. I presented it to Steve, and he was happy. He told me not to put any of the elements that were removed back in the model. He told me that this simpler model was the first chapter of my dissertation. I was more than surprised. I feel that I would still be in graduate school if I had not had Steve Ross as an advisor. He encouraged me to do what I was good at and mattered to me, not what others seemed to value. He continued to be a friend and mentor until he passed away in 2017.

I became a recruiter for Steve, telling my friends to take his course and try to work with him.  I convinced Greg Connor, Mark Grinblatt and Paul Pfleiderer to go take Steve’s course. Each ended up with Steve as their advisor. They have all thanked me several times. All were also very helpful with my research, especially Greg Connor.

I rushed to finish my dissertation in my fourth year, which was the normal time of completion in those days. I got my job market paper to Steve around Thanksgiving, which was a bit late. It contained two chapters of what would be my dissertation, including an early version of Financial Intermediation and Delegated Monitoring. I did reasonably well in getting interviews at the Allied Social Science Associations (ASSA) meetings in Chicago from business schools and departments of economics, but the University of Chicago did not interview me. I did interview with Professor Nancy Jacob from the University of Washington, who worked on banking. She told Professor Robert Hamada from the University of Chicago Graduate School of Business about my work. After the ASSA meetings, I received a letter in the US mail from Robert Hamada inviting me to send my materials to him. Soon, the GSB invited me to visit campus and present my paper. By this time, I had a job offer from the Wharton School of the University of Pennsylvania, with a pending deadline for acceptance. I visited Wharton on the day of their deadline. I was sitting in Sandy Grossman’s office when a call came (to Sandy’s phone) from the deputy dean at the Chicago GSB, with a job offer. Sandy Grossman encouraged me to come to Wharton but made it clear that he had a high opinion of the University of Chicago. Despite Sandy’s encouragement, I accepted Chicago’s offer. Sandy eventually became a highly valued colleague when he joined Chicago’s economics department two years later.

The University of Chicago

The University of Chicago Graduate School of Business (GSB) was especially vibrant when I joined in late 1979. The senior finance faculty members in finance were Merton Miller, Gene Fama, Myron Scholes, Robert Hamada and James Lorie. The first three were future Economics Prize Laureates and were always around to give feedback. The junior faculty members were George Constantinides and John Ingersoll. I was put in a suite with Fama, Scholes, Lorie and Ingersoll. All provided helpful feedback, especially Gene Fama, who was also doing research on banking at the time. I would feel like a very hard worker when I went to the office on a Sunday morning until I found that Gene had been there already working for several hours. The finance group was very small, so I started near the top.  Myron Scholes read my paper on Delegated Monitoring and advised me to improve the exposition before I submitted it. This took quite a while, and I waited until 1982 to submit it.  

From my first days at Chicago, I also had good interaction with members of the Department of Economics. I attended the Money and Banking workshop and got comments and advice from Bob Lucas and José Scheinkman in particular. Charlie Kahn joined the department soon after and also became a great colleague. Sandy Grossman joined two years later.  

At Chicago, I met Robert (Ro) Verrecchia, a new Assistant Professor of Accounting hired the year that I joined. Ro was a Stanford GSB student of Robert Wilson. He was developing theories of information in market prices and the link of prices to information from accounting. I was focusing on rational expectations models of asset prices. We decided to work together, and I converted Ro to rational expectations models, which were very similar mathematically to the models he had been building. Ro taught me how to write papers more clearly and to overcome excessive perfectionism. My first two publications were with Ro. We wrote a series of papers and became good friends. Ro left Chicago for Wharton in 1983, which slowed our collaboration but did not end it.

Personal life

After a year in Chicago, I met my future wife, Elee (Elizabeth B. Cammack). We quickly spent lots of time together, although we were both working very hard. We were married less than two years later. Elee is also an economist in empirical finance. She is brilliant, charming, fun and much more organized than I am. We have two wonderful children. Our daughter, Rebecca, was born in Chicago in 1984. Our son, William, was born in Chicago in 1989. We are very proud of them, and both are economists. Our family does not have a well-diversified portfolio of human capital, but we do enjoy sharing economics jokes at the dinner table.

Working with Phil Dybvig

In 1981, Phil Dybvig and I began a project on game theoretic models of finance. We decided to try to understand bank runs as multiple Nash equilibria. Bank runs and financial crises are an important part of economic history, and I had read the details of the US runs when I studied Friedman and Schwartz. We made some progress while we were at the Western Finance Association meetings in Grand Teton National Park. We had similar training but different modeling styles, so we debated the structure of the model before we entered into model solving. We originally had the idea that we might explain in the model why bank loans are illiquid. Our idea was that banks had private information about the ex-post prospects of loans made previously. They might have incentives to roll over bad loans and declare their payments to be current, rather than to foreclose and reveal bad news to depositors. Selling a loan that might be bad would then have an asymmetric information lemons problem. After thought and discussion, we agreed that the reason that loans were illiquid was less important than the illiquidity itself. In addition, if we just assumed that the loans were illiquid, we could set up a model where loans held to maturity were free of risk, with a clean logical separation between insolvent and illiquid banks. We hoped that the ideas in the model could influence policy makers, so we worked hard on both simplicity and intuitive exposition.

It was a great pleasure to work with Phil. He understands things quickly, has a great intuition, and an amazing ability to use the right type and amount of mathematics. The paper writing process went quickly, and we sent it to the Journal of Political Economy. We got a very useful and very positive referee report, which recommended acceptance with minor changes. The editor, Michael Mussa, wrote us a long letter suggesting quite a few changes. We made the changes, and the paper was accepted. This is the fastest editorial process I have yet experienced at an economics journal.

Phil Dybvig and I wrote only one other paper together, in 1986. We applied the ideas in from our model of bank runs and my model of delegated monitoring to practical issues in the regulation of financial intermediaries, both bank and non-bank. We remain friends and still bounce new ideas off each other.

A Year at Yale SOM

In 1987, Elee and I joined the faculty of the Yale School of Management. Unfortunately for all, the president of the university had removed the dean and was reevaluating the future of the management school after we decided to join and just before we arrived. Its future looked precarious and its present was unpleasant. After several months, I called Bob Hamada, who was deputy dean at Chicago GSB, and asked if I could still return to Chicago. He said that he had just finished processing my resignation but would talk to the senior faculty in finance and get back to me. He soon told me that I could come back, and we returned to Chicago in 1988.

The year at Yale was difficult, but I did enjoy having great colleagues in the management school, including Steve Ross, Phil Dybvig, Bengt Holmström and Jon Ingersoll. After that year at Yale, I never again complained about anything at the University of Chicago. Thankfully, Yale SOM subsequently recovered from that period.

A Career at The University of Chicago

After Ro Verrecchia left Chicago, we wrote two more papers together (our most cited), but for several years, I mainly wrote papers by myself. I relied on my colleagues in the profession and at Chicago for feedback on my work. My wife Elee helped me through this period by giving feedback after listening to me talk about projects, and she greatly helped me with the mathematical proofs in my 1989 paper on reputation acquisition.

In the 1980s and 1990s, Chicago hired many great young faculty members in finance, and many were working on finance theory. I learned a lot from them, especially Gur Hubermann (also a student of Steve Ross), Charlie Jacklin, Rob Visnhy, Andrei Shleifer, Ken French, Anil Kashyap (a co-author), Kent Daniel, Raghu Rajan (a co-author), John Cochrane, Luigi Zingales, Per Strömberg and Ulf Axelson. We did not frequently hire outside tenured faculty, but I was lucky that we hired the great Milt Harris in 1987. Chicago Booth (then GSB) is and was an exciting place to do research. We take each other’s research seriously, and all attempt to help improve what we all do. Some find our workshop comments intense, but in the end they improve the quality of papers.

In 1991, Chicago hired Raghu Rajan, who worked on corporate finance and banking. In addition to being a great researcher, Raghu has an unusually broad perspective on the world and its problems. He has been a great colleague and friend from the first day he arrived. Raghu got tenure in four years, and a bit after that, we began our joint work. We continue to work together.

Chicago hired Zhiguo He in 2008, and he has been a very close and insightful colleague and friend since then. We have written a paper together and continue to talk regularly about research.

I have learned from and greatly enjoyed advising many great PhD students at Chicago, 62 at last count. I pass along the philosophy that I learned from Steve Ross: I listen to what each is trying to do and give each my take on how to explain or improve it. My students work on many diverse fields of finance, and most of their research is reasonably far from mine. I am proud of them all. Rather than thanking them individually, I thank them all and especially those who organized a great conference for my students around my 65th birthday. For this, I thank Effi Benmelech, Philip Bond, Andrea Eisfeldt and David Musto. I am also very grateful to Yunzhi Hu for putting together a set of videos and written messages that he presented to me in Stockholm the day before I received the Economics Prize in honor of Alfred Nobel.

The Richmond Fed

I have been a regular visiting scholar at the Federal Reserve Bank of Richmond starting in 1990 and every year before 2020, when Covid ended my regular visits. I was invited after they hired Jeff Lacker and John Weinberg, who were working on issues close to those that I study. I talked to them frequently, and to Marvin Goodfriend (who I knew from Brown) and Mike Dotsey. In later years, Ned Prescott and Huberto Ennis were my closest colleagues there. Those discussions and those over lunch with members of the research department and the bank presidents kept me in touch with macroeconomics and central banking.

Public Policy

My research deals with issues that have implications for public policy regarding the financial system. Usually, I present my ideas via scholarly papers, communicating to scholars, policy makers and a few practitioners. During the 2007–2009 period, I spent time working directly on policy proposals and entering into discussions with policy makers. Ken French recruited me to join a group of economists to propose some changes to financial regulation, and the result was the Squam Lake Report. I became an informal advisor to the US Treasury and made policy presentations to the Federal Reserve Board. Together with Chicago Booth colleagues, I wrote op-ed pieces and blog posts for the public. I was pleased to be able to participate in the crisis response, but I was happy when the crisis faded and I could get back to doing research with a longer time horizon.

After the Crisis

Life settled down a bit by 2010. I returned to my research program and worked on two papers with Raghu Rajan, applying our previous models to issues in financial stability. We used some insights from the crisis to frame the questions. In 2012, Raghu went to India, first to advise the finance ministry and then to become the Governor of the Reserve Bank of India until 2016. We continued to work on the research projects that we started, which are not exclusively about financial intermediation, but at a slower pace. A few years later, we began to work together with Yunzhi Hu of the University of North Carolina, and we continue to do so. Yunzhi adds a new perspective to our work, both empirical and theoretical. Yunzhi is a former PhD student of mine and the only student that I have ever had as a co-author. He, too, is a friend from whom I continue to learn.

I have not been someone who worked from home (at least not before the Covid pandemic). Chicago Booth is a place where most of us are in the office almost five days a week. My colleagues have always been helpful to my research, but my set of co-authors has always been small. In the period after Raghu went to India, I greatly enjoyed working on a paper with Zhiguo He on debt overhang, showing that short-term debt leads to more debt overhang than long-term debt, in some circumstances. I collaborated with Anil Kashyap, producing a paper on the optimal regulation of liquidity holdings by banks. This is my first paper, other than those with Phil Dybvig, to use a version of the Diamond-Dybvig model. Anil and I generalized it to partial runs, which has surprising implications for liquidity regulation.

I visited the MIT Sloan School in the 2015–16 academic year. Apart from my year at Yale SOM, this was my only year away from Chicago since I joined in 1979. I enjoyed visiting their department of finance. I would have enjoyed it more, but my mother’s health deteriorated, and I flew back to Chicago many times to help her. I got to know all of the Sloan finance junior faculty, who joined me for lunch every day, and I reconnected with the senior faculty. Steve Ross was on leave, regrettably. I also spent many fascinating hours talking to Bengt Holmström from MIT’s department of economics. A great bonus of the visit to Cambridge was the ability for me and Elee to spend some very pleasant time with our son Will, who was working on his PhD in economics at Harvard.

After our return to Chicago, scholarly life was as usual, but personal life became very busy. My mom’s health continued to deteriorate, and she passed away in 2017. On a happier note, our first granddaughter (Rebecca’s daughter) was born that year, and we spent very happy times visiting her. Rebecca’s son was born in 2020, just before the extent of the pandemic became clear. In 2021, my father’s health deteriorated, and he passed away in the middle of 2022.

Life began to return to normal. Raghu, Yunzhi and I continued working on a project that is quite different from our previous research. On a flight back from a conference, I made some progress on it, and we had plans to discuss the project that week. Very early the next morning, October 10, 2022, I received a phone call from Stockholm.

© The Nobel Foundation 2024