Overconfidence and risk seeking in credit markets: an experimental game
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- Peón, D., Antelo, M. & Calvo, A. Rev Manag Sci (2016) 10: 511. doi:10.1007/s11846-015-0166-8
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Behavioral biases may influence bank decisions when granting credit to their customers. This paper explores this possibility in an experimental setting, contributing to the literature in two ways. First, we designed a business simulation game that replicates the basic decision-making processes of a bank granting credit to clients under conditions of risk and uncertainty. Second, we implemented a series of short tests to measure participants’ overconfidence and risk profile according to prospect theory and then conduct an experimental implementation of the simulation game. We find that higher levels of overprecision and risk seeking for gains (mostly attributable to distortion of probabilities) foster lower prices and higher volumes of credit, and reduce quality. The most consistent result is that distortion of probabilities affects the ability to discriminate between the quality of borrowers according to objective information, fostering strategies of lower loan prices to lower quality clients. The external validity of the results is also discussed.