Monopolistic Screening Under Mental Accounting: Applications to Loan Markets with Collateral

Kim Byung-Cheol ()
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Kim Byung-Cheol: Department of Economics, Finance and Legal Studies, Culverhouse College of Business, University of Alabama, 200 Alston Hall, Tuscaloosa, AL 35487, USA

Review of Network Economics, 2022, vol. 21, issue 3, 111-142

Abstract: This paper extends the standard model of monopolistic screening to allow for some consumers who engage in narrow framing, a prominent behavioral bias of mental accounting. Narrow framing generates a bias toward high quality-price ratios, which induces even high-type consumers to choose a menu that targets low-type consumers. To strategically account for narrow framing, when the monopolist induces the high-type consumers to stay with the more expensive menu, there arises a downward quality distortion even at the top and a smaller downward distortion at the bottom. Then, we apply this model to optimal loan contracts to screen heterogeneous borrowers with different default risks. We find that the lender optimally reduces the collateral requirement for low-risk borrowers when some high-risk borrowers are subject to narrow framing. This result empirically implies that narrow framing may lead to smaller credit rationing and lower monitoring intensity in the lending markets.

Keywords: adverse selection; behavioral contract theory; collateral; narrow framing; non-linear price discrimination (search for similar items in EconPapers)
JEL-codes: A12 D03 D82 D86 G4 M31 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1515/rne-2023-0030

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