Social Norms and Strategic Default

51 Pages Posted: 8 Mar 2016 Last revised: 30 Jun 2017

See all articles by Martin Brown

Martin Brown

University of St. Gallen

Jan Schmitz

ETH Zurich

Christian Zehnder

University of Lausanne

Date Written: June 2017

Abstract

This paper studies the behavioral mechanisms underlying the increase in strategic defaults during an economic crisis. We report data from a laboratory experiment in which we exogenously vary the state of the economy. Our data reveal two main reasons for why an economic contraction adversely affects repayments. First, weak economic conditions seem to soften debtors' moral constraints. When surrounded by insolvency, solvent debtors become less hesitant to default strategically. Second, an economic downturn also undermines the enforcement of social repayment norms by peers. However, we find that the decrease in norm enforcement is not caused by a break-down of the repayment norm itself, but rather is a consequence of the additional informational uncertainty that weak economic conditions create. In a crisis peers are reluctant to sanction defaulters, because the risk of harming innocent debtors is higher.

Keywords: Strategic Default, Moral Constraints, Social Norms

JEL Classification: G01, G02, C91

Suggested Citation

Brown, Martin and Schmitz, Jan and Zehnder, Christian, Social Norms and Strategic Default (June 2017). University of St. Gallen, School of Finance Research Paper No. 2016/08. Available at SSRN: https://ssrn.com/abstract=2743278 or http://dx.doi.org/10.2139/ssrn.2743278

Martin Brown (Contact Author)

University of St. Gallen ( email )

Unterer Graben 21
St. Gallen, CH-9000
Switzerland

Jan Schmitz

ETH Zurich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Christian Zehnder

University of Lausanne ( email )

Quartier Chambronne
Lausanne, Vaud CH-1015
Switzerland

Register to save articles to
your library

Register

Paper statistics

Downloads
137
Abstract Views
1,037
rank
210,468
PlumX Metrics