Optimal Lending Contracts with Retrospective and Prospective Bias
AbstractModel misspecification is a common approach to model belief formation distortions. Misspecified models can be decomposed into two classes of distortions: prospective and retrospective biases (Bohren and Hauser 2023). Prospective biases correspond to distortions in forecasting future beliefs, while retrospective biases correspond to distortions in interpreting information ex post. We disentangle the impact of these two distortions on optimal lending contracts in the context of an entrepreneur who borrows to invest in a project. The entrepreneur learns about project quality from a signal, which she interprets with a misspecified model. A lender leverages each form of bias in distinct ways.
CitationBohren, J. Aislinn, and Daniel N. Hauser. 2023. "Optimal Lending Contracts with Retrospective and Prospective Bias." AEA Papers and Proceedings, 113: 665-72. DOI: 10.1257/pandp.20231115
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- D86 Economics of Contract: Theory
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- L26 Entrepreneurship