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Looking underwater in the lab

The timing of default can greatly affect an individual’s wealth. This paper empirically studies the optimal stopping decision —default— where subjects have the alternative to stop paying a loan on the asset whose value is governed by the Brownian motion. The optimal policy is to stop when the asset value crosses the optimal threshold defined by a real deferral option, where the deferral option value depends on the volatility as well as the actions of others. Surprisingly, I find that subjects follow the theoretical predictions of the model. The neighbors effect turns out to be less important in the high volatility treatments, but in the low volatility treatments, the presence of neighbors leads to a higher rate of default.