Using Behavioral Economics to Analyze Credit Policies on the Banking Industry
15 Pages Posted: 5 May 2011
Date Written: September 9, 2010
2008 world financial meltdown highlighted significant shortcomings on procedures used by the banking sector to provide credit to the real economy. A long period of indulgence granting personal loans and mortgages that boosted a credit bubble all over the world has been followed by an era of suspicion within the banking sector, precipitating the liquidity crunch and the credit squeeze to private agents.
The efficient market hypothesis (EMH) claims that asset prices are equal to their fundamental values either because all investors are rational or, if not all them are so, arbitrage does eliminate pricing anomalies. But empirical evidence on stock markets seems to contradict EMH in many cases. During the last thirty years, Behavioral Finance has emerged as an alternative approach to analyze efficiency on financial markets, revealing a world with less than fully rational investors and arbitrageurs limited by risk aversion, short time horizons and agency problems.
On this paper we consider on one hand the possibility to extend Behavioral Finance topics such as investor sentiment, overconfidence, heuristics or herd instinct to analyze banks behavior when providing credit to private agents; and on the other hand, how the absence of arbitrageurs in the credit market could justify the role of public banking as a countercyclical policy maker.
Keywords: Behavioral Finance, retail credit market, banking regulation, arbitrage, efficiency, EMH
JEL Classification: G14, G21, E51
Suggested Citation: Suggested Citation