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Banker Compensation and Confirmation Bias

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  • Sabourian, H.
  • Sibert, A.C.

Abstract

Confirmation 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 Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0940.

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Date of creation: 12 Oct 2009
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Handle: RePEc:cam:camdae:0940

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Web page: http://www.econ.cam.ac.uk/index.htm

Related research

Keywords: confirmation bias; belief persistence; overconfidence; signalling; credit crisis;

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References

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  1. Hirshleifer, David, 2001. "Investor Psychology and Asset Pricing," MPRA Paper 5300, University Library of Munich, Germany.
  2. Hirshleifer, David & Teoh, Siew Hong, 2001. "Herd Behavior and Cascading in Capital Markets: A Review and Synthesis," MPRA Paper 5186, University Library of Munich, Germany.
  3. David Kreps & Robert Wilson, 1999. "Reputation and Imperfect Information," Levine's Working Paper Archive 238, David K. Levine.
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  7. Dewatripont, Mathias & Jewitt, Ian & Tirole, Jean, 1999. "The Economics of Career Concerns, Part I: Comparing Information Structures," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 183-98, January.
  8. Ottaviani, Marco & Sorensen, Peter Norman, 2006. "Professional advice," Journal of Economic Theory, Elsevier, vol. 126(1), pages 120-142, January.
  9. Avery, Christopher N. & Chevalier, Judith A., 1999. "Herding over the career," Economics Letters, Elsevier, vol. 63(3), pages 327-333, June.
  10. Eric Van den Steen, 2004. "Rational Overoptimism (and Other Biases)," American Economic Review, American Economic Association, vol. 94(4), pages 1141-1151, September.
  11. Mailath, George J, 1987. "Incentive Compatibility in Signaling Games with a Continuum of Types," Econometrica, Econometric Society, vol. 55(6), pages 1349-65, November.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Bankers compensation
    by Kevin Denny in Geary Behaviour Centre on 2009-10-25 09:04:00
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Cited by:
  1. Anne Sibert, 2010. "Sexism and the City: Irrational Behaviour, Cognitive Errors and Gender in the Financial Crisis," Open Economies Review, Springer, vol. 21(1), pages 163-166, February.

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