DP7263 Banker Compensation and Confirmation Bias

Author(s): Hamid Sabourian, Anne Sibert
Publication Date: April 2009
Keyword(s): belief persistence, confirmation bias, financial crisis, overconfidence, signalling
JEL(s): D81, D82, D83, G21
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7263

Confirmation bias refers to cognitive errors that bias one towards one's own prior beliefs. A vast empirical literature documents its existence and psychologists identify it as one of the most problematic aspects of human reasoning. In this paper, we present three related scenarios where rational behaviour leads to outcomes that are observationally equivalent to different types of conformation bias. As an application, the model provides an explanation for how the reward structure in the financial services industry led to the seemingly irrational behaviour of bankers and other employees of financial institutions prior to the financial crisis of that erupted in the summer of 2007.