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Strategic Loan Defaults and Coordination: An Experimental Analysis

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  • Stefan Trautmann
  • Razvan Vlahu

Abstract

This paper experimentally studies the impact of uncertainty about bank and borrower fundamentals on loan repayment. We find that solvent borrowers are more likely to default strategically when stricter disclosure creates common knowledge about bank weakness. Borrowers are also less likely to repay in the presence of higher uncertainty regarding other. Borrowers' financial health, regardless of disclosure rules. We show that uncertainty about fundamentals changes the risk dominance properties of the coordination problem, and that these changes subsequently explain borrowers' default. 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

Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 312.

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Date of creation: Aug 2011
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Handle: RePEc:dnb:dnbwpp:312

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Keywords: credit market; strategic default; loss aversion; risk dominance; transparency;

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Cited by:
  1. 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.
  2. Breaban, A. & Noussair, C.N., 2013. "Emotional state and Market Behavior," Discussion Paper 2013-031, Tilburg University, Center for Economic Research.

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