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Behavioral Biases in Interest Rate Risk Management: Overconfidence and the Use of Forward Rate Agreements in Nigerian Banks

Oyetade, John Akinbiyi PhD, FCA, ADESANYA, Abel Olusegun PhD, JohnsonRokosu, Samuel, FCA, Msc

Abstract

This study examines how overconfidence bias affects the use of forward rate agreements (FRAs) by Nigerian banks to manage interest rate risk, and addresses a critical gap in African behavioural finance research. The mixed method combines a panel regression analysis of FRA prices and volume of trades (2015-23) with semi-structured interviews with 20 Nigerian risk managers. The central bank of Nigeria (CBN) and FMDQ OTC Securities Exchange (FMDQ) quantitative data were analyzed using fixed-effects models, while qualitative information was coded to identify behavioural narratives. Overconfidence, driven by the length of tenure of the CEO (>5 years) and historical forecasting errors, is correlated with a 23 percent higher FRA error (p<0.01) and an excessive speculative volume. Banks with poor governance (e.g. frequent meetings of the risk committee) incurred 15 percentage points higher losses (p<0.05). Transparency measures have reduced speculation by 9 percent (p<0.10), but have not reduced mispricing, underlining the persistence of cognitive biases. The study advocates regulatory reforms, including mandatory disclosure of behavioural risks in Basel III compliance frameworks and standardised FRA price quotations. For professionals, it recommends debriefing protocols such as pre-mortem analysis and stress testing exercises. This is the first empirical study to integrate behavioural finance and derivative techniques in the context of African banking, challenging the hegemony of the emerging markets model of rational agents.

Keywords

Behavioral financeOverconfidence biasForward Rate Agreements (FRAs)

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