Why the difference? It wasn’t because of a difference in the available information. As Koudijs and Voth point out, everybody in Dutch financial circles knew and understood the magnitude of what had happened. Nor was it because the Seppenwolde lenders had to rebuild their own finances. Within weeks of the default, the lenders knew they hadn’t lost any money.
Yet, the disparity in haircuts lasted for almost two years. In fact, the pessimism and risk-aversion of the Seppenwolde lenders reduced the overall availability of leverage in Amsterdam.
In a rigorous analysis of Dutch financial records, Koudijs and Voth conclude that the only real difference between the pessimists and the optimists was whether they had gone through a harrowing personal experience. Koudijs compares it to the behavior of people who lived through the Great Depression, and who avoided financial risk for decades after trauma had passed.
The Dutch case involved sophisticated financial professionals, people accustomed to analyzing financial and economic trends. Yet, they too focused on their personal experience.
“It suggests that people put more weight on what happened to themselves and less weight on other information that might be available,”Koudijs says. The more personally removed people are from an important event, the less it is to affect their appetite for risk.
It’s not clear which group of Dutch lenders was wrong. It’s possible that the Seppenwolde lenders ignored the evidence about broader financial conditions and were too pessimistic. It’s also possible that the other lenders were too casual in brushing off the implications of the East India mess. Either way, the Dutch episode suggests that even sophisticated investors become optimistic or pessimistic for myopic reasons.
To Koudijs, this has important regulatory implications for heading off 21st-century bubbles and busts.
“If lenders are too optimistic during market booms and too pessimistic in downturns, that could be a good reason for authorities to set conservative capital requirements,” he suggests. “Higher haircuts might dampen the initial run-ups, but they could also dampen the subsequent fallouts when tides turn.”
Peter Koudijs is an assistant professor of finance at Stanford Graduate School of Business.