Come across a very interesting paper arguing about the role of overconfidence in lending relationship. In previous works, e.g. Professor Ulrike Malmendier’s papers, overconfidence and behavior bias are considered as a key driver in many actions cannot be explained by rational agent models. This paper, Lending to Overconfident Borrowers, highlights another interesting part from the bank’s perspective. Authors argue that collateral-based lenders are more likely to extend credits to these overconfident borrowers. This make perfect sense as now creditors with collateral in hand care less about the monitoring, given they are largely protected from the downside. This is exactly the prediction from Collateral Booms and Information Depletion that collateral boom and the extensive use of collateral to crowd out the screening.
This is very interesting paper.