Hysteresis in Banking and Financial Industry

Abstract

This research provides the theoretical foundations for introducing hysteresis, the historic memory or path dependency, into the banking and financial industry. This is done by generalizing the popular Monti-Klein model of banking competition, to allow for both fixed entry and per-period cost/subsidy. However, the empirically relevant case of zero per-period fixed costs is considered as well. As will be shown, such a model implies multiple path dependent equilibria of banks' activities or in other words Hysteresis. The implications of the theory of hysteresis developed herein are tested by applying a breakpoint unit root tests to the historical U.S. data on banking. These tests find evidence for hysteresis in the commercial banking sector in most but not all U.S. states.

Keywords: hysteresis, Monti-Klein model, microeconomics of banking, unit root testing

JEL Classification: G21, D20, L10