Ahrens, Steffen (TU Berlin)
Bosch-Rosa, Ciril (TU Berlin)
One of the reasons for the recent crisis is that financial institutions took “too much risk” (Brunnermeier, 2009; Taylor et al., 2010). Why were these institutions taking so much risk is an open question. A recent strand in the literature points towards the “cognitive dissonance” of investors who, because of the limited liability of their investments, had a distorted view of riskiness (e.g., Barberis (2013); Benabou (2015)). In a series of laboratory experiments we show how limited liability does not affect the beliefs of investors, but does increase their willing exposure to risk. This results points to a simple explanation for the over-investment of banks and hedge-funds: When incentives are not aligned, investors take advantage of the moral hazard opportunities.
moral hazard; cognitive dissonance; behavioral finance
C91; D84; G11; G41