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Strategic loan defaults and coordination: An experimental analysis

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  • Trautmann, Stefan T.
  • Vlahu, Razvan

Abstract

This paper experimentally studies the impact of bank and borrower fundamentals on loan repayment. We find that solvent borrowers are more likely to default strategically when the bank’s expected strength is low, although loan repayment is a Pareto dominant Nash equilibrium. Borrowers are also less likely to repay when other borrowers’ expected repayment capacity is low, regardless of banks’ fundamentals. We show that changes in expectations about bank and borrower fundamentals change the risk dominance properties of the borrowers’ coordination problem, and that these changes subsequently explain strategic defaults. For the individual borrower, loss aversion and negative past experiences reduce repayment, suggesting that bank failure can be contagious in times of distress.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 37 (2013)
Issue (Month): 3 ()
Pages: 747-760

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Handle: RePEc:eee:jbfina:v:37:y:2013:i:3:p:747-760

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Web page: http://www.elsevier.com/locate/jbf

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Keywords: Credit market; Strategic default; Loss aversion; Risk dominance; Contagion;

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Cited by:
  1. Adriana Breaban & Charles N. Noussair, 2013. "Emotional State and Market Behavior," Working Papers 2013/08, Economics Department, Universitat Jaume I, Castellón (Spain).
  2. Hubert Janos Kiss & Ismael Rodriguez-Lara & Alfonso Rosa-Garcia, 2013. "Do Social Networks Prevent or Promote Bank Runs?," IEHAS Discussion Papers 1344, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.

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