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

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  • Wong, Kit Pong

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.

Suggested Citation

  • Wong, Kit Pong, 2011. "Regret theory and the banking firm: The optimal bank interest margin," Economic Modelling, Elsevier, vol. 28(6), pages 2483-2487.
    • Handle: RePEc:eee:ecmode:v:28:y:2011:i:6:p:2483-2487
    DOI: 10.1016/j.econmod.2011.07.007
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    References listed on IDEAS

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