Staff Report 79

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A New Explanation for Free Bank Failures

Arthur J. Rolnick - Senior Vice President and Director of Research, 1985-2010
Warren E. Weber - Retired Economist

Revised November 1, 1982

Abstract
In this paper we propose and test a new explanation of bank behavior during the Free Banking Era, 1837–63. Arguing against the view that free bank failures were due to fraud, we claim that they were caused by exposure to term structure risk. Testing this new explanation with a new and extensive body of data, we find strong support for it: periods of falling bond prices correspond to the periods with most of the free bank failures. The new data do not support the view that fraud caused the failures.


Published In: Journal of Monetary Economics (Vol 14, Num 3, November 1984, pp. 267-291)

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