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Lending to Overconfident Borrowers

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Listed:
  • De Marco, Filippo
  • Sauvagnat, Julien
  • Sette, Enrico

Abstract

We study how banks lend to overconfident borrowers. For identification, we exploit variation in pupils’ overconfidence across areas in Italy. We find that borrowers born in overconfident areas make larger forecast errors on future sales, pay higher loan rates and are more likely to be denied credit. Consistent with a credit market model where borrowers have biased beliefs, collateral-based banks are more likely to grant credit to overconfident borrowers, who then invest and default more than others. We estimate that bad loans in Italy would be €10 billion (8%) lower in 2017 if banks relied less on collateral when lending to overconfident borrowers.

Suggested Citation

  • De Marco, Filippo & Sauvagnat, Julien & Sette, Enrico, 2021. "Lending to Overconfident Borrowers," CEPR Discussion Papers 15785, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:15785
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    More about this item

    Keywords

    Optimism; Business expectations; Loan applications; Borrower default; Collateral requirements;
    All these keywords.

    JEL classification:

    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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