Strategic loan defaults and coordination

An experimental analysis

S.T. Trautmann, R. Vlahu

Research output: Contribution to journalArticleScientificpeer-review

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.
Original languageEnglish
Pages (from-to)747-760
JournalJournal of Banking and Finance
Volume37
Issue number3
DOIs
Publication statusPublished - 2013

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Loans
Experimental analysis
Pareto
Coordination problems
Loss aversion
Nash equilibrium
Risk dominance
Bank failure
Distress

Cite this

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Strategic loan defaults and coordination : An experimental analysis. / Trautmann, S.T.; Vlahu, R.

In: Journal of Banking and Finance, Vol. 37, No. 3, 2013, p. 747-760.

Research output: Contribution to journalArticleScientificpeer-review

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