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Social Norms and Strategic Default

Martin Brown (), Jan Schmitz and Christian Zehnder ()

No 1608, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: This paper studies the behavioral mechanisms underlying the increase in strategic defaults during an economic crisis. We report data from a laboratory experiment in which we exogenously vary the state of the economy. Our data reveal two main reasons for why an economic contraction adversely affects repayments. First, weak economic conditions seem to soften debtors' moral constraints. When surrounded by insolvency, solvent debtors become less hesitant to default strategically. Second, an economic downturn also undermines the enforcement of social repayment norms by peers. However, we find that the decrease in norm enforcement is not caused by a break-down of the repayment norm itself, but rather is a consequence of the additional informational uncertainty that weak economic conditions create. In a crisis peers are reluctant to sanction defaulters, because the risk of harming innocent debtors is higher.

Keywords: Strategic Default; Moral Constraints; Social Norms (search for similar items in EconPapers)
JEL-codes: G01 G02 C91 (search for similar items in EconPapers)
Date: 2016-03, Revised 2017-06
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