Banker Compensation and Confirmation Bias
AbstractConfirmation bias refers to cognitive errors that bias one towards one's own prior beliefs. A vast empirical literature documents its existence and psychologists identify it as one of the most problematic aspects of human reasoning. In this paper, we present three related scenarios where rational behaviour leads to outcomes that are observationally equivalent to different types of conformation bias. As an application, the model provides an explanation for how the reward structure in the financial services industry led to the seemingly irrational behaviour of bankers and other employees of financial institutions prior to the credit crisis of that erupted in the summer of 2007.
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Bibliographic InfoPaper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0940.
Date of creation: 12 Oct 2009
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Web page: http://www.econ.cam.ac.uk/index.htm
confirmation bias; belief persistence; overconfidence; signalling; credit crisis;
Other versions of this item:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-10-24 (All new papers)
- NEP-CBE-2009-10-24 (Cognitive & Behavioural Economics)
- NEP-NEU-2009-10-24 (Neuroeconomics)
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