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Regret theory and the banking firm: The optimal bank interest margin

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  • Wong, Kit Pong
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    Abstract

    This paper examines the optimal bank interest margin, i.e., the spread between the loan rate and the deposit rate of a bank, when the bank is not only risk-averse but also regret-averse. Regret-averse preferences are characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the presence of regret aversion raises or lowers the optimal bank interest margin than the one chosen by the purely risk-averse bank, depending on whether the probability of default is below or above a threshold value, respectively. Regret aversion as such makes the bank less prudent and more prone to risk-taking when the probability of default is high, thereby adversely affecting the stability of the banking system.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0264999311001787
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    Bibliographic Info

    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 28 (2011)
    Issue (Month): 6 ()
    Pages: 2483-2487

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    Handle: RePEc:eee:ecmode:v:28:y:2011:i:6:p:2483-2487

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    Web page: http://www.elsevier.com/locate/inca/30411

    Related research

    Keywords: Bank interest margins; Banking firms; Credit risk; Regret theory;

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    Cited by:
    1. Tsai, Jeng-Yan, 2013. "Bank interest margin management based on a path-dependent Cobb–Douglas utility framework," Economic Modelling, Elsevier, vol. 35(C), pages 751-762.
    2. Broll, Udo & Eckwert, Bernhard & Eickhoff, Andreas, 2012. "Financial intermediation and endogenous risk in the banking sector," Economic Modelling, Elsevier, vol. 29(5), pages 1618-1622.
    3. Wong, Kit Pong, 2014. "Regret theory and the competitive firm," Economic Modelling, Elsevier, vol. 36(C), pages 172-175.
    4. Tsai, Jeng-Yan, 2012. "Risk and regret aversions on optimal bank interest margin under capital regulation," Economic Modelling, Elsevier, vol. 29(6), pages 2190-2197.
    5. Lin, Jyh-Horng & Hung, Wei-Ming, 2013. "A barrier option framework for bank interest margin management under anticipatory regret aversion," Economic Modelling, Elsevier, vol. 33(C), pages 794-801.
    6. Wong, Kit Pong, 2012. "Production and insurance under regret aversion," Economic Modelling, Elsevier, vol. 29(4), pages 1154-1160.
    7. Udo Broll & Anna Sobiech & Jack E. Wahl, 2012. "Banking Firm, Equity and Value at Risk," Contemporary Economics, University of Finance and Management in Warsaw, vol. 6(4), December.
    8. Wong, Kit Pong, 2013. "Fixed versus variable rate loans under state-dependent preferences," Economic Modelling, Elsevier, vol. 31(C), pages 659-663.
    9. Chang, Chuen-Ping, 2014. "A barrier option framework for rescue package designs and bank default risks," Economic Modelling, Elsevier, vol. 38(C), pages 246-257.

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