Optimal Lending Contracts with Retrospective and Prospective Bias

J. Aislinn Bohren and Daniel N. Hauser

AEA Papers and Proceedings, 2023, vol. 113, 665-72

Abstract: Model 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.

JEL-codes: D83 D86 G21 G32 L26 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1257/pandp.20231115

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