Regret theory and the banking firm: The optimal bank interest margin

Kit Pong Wong

Economic Modelling, 2011, vol. 28, issue 6, 2483-2487

Abstract: This paper examines the optimal bank interest margin, i.e., the spread between the loan rate and the deposit rate of a bank, when the bank is not only risk-averse but also regret-averse. Regret-averse preferences are characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the presence of regret aversion raises or lowers the optimal bank interest margin than the one chosen by the purely risk-averse bank, depending on whether the probability of default is below or above a threshold value, respectively. Regret aversion as such makes the bank less prudent and more prone to risk-taking when the probability of default is high, thereby adversely affecting the stability of the banking system.

Keywords: Bank interest margins; Banking firms; Credit risk; Regret theory (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (27)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:28:y:2011:i:6:p:2483-2487

DOI: 10.1016/j.econmod.2011.07.007

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