This note provides an example of a case where …nancial instability can be ampli…ed by stable fundamentals rather than risky fundamentals, using a variation of Diamond and Rajan (2009). Paper type – Research paper

This paper develops a dynamic general equilibrium model that explicitly includes a banking sector engaged in a maturity mismatch. We demonstrate that rational competitive banks take on excessive risks systemically, resulting in overleverage and ine¢ ciently high crisis probabilities. The model...