Neglected Risks: The Psychology of Financial Crises | Zendy

Nicola Gennaioli | Zendy; Andrei Shleifer | Zendy; Robert W. Vishny | Zendy

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Neglected Risks: The Psychology of Financial Crises

Author(s) -

Nicola Gennaioli,

Andrei Shleifer,

Robert W. Vishny

Publication year - 2015

Publication title -

american economic review

Language(s) - English

Resource type - Journals

SCImago Journal Rank - 16.936

H-Index - 297

eISSN - 1944-7981

pISSN - 0002-8282

DOI - 10.1257/aer.p20151091

Subject(s) - economics , representativeness heuristic , bust , volatility (finance) , neglect , debt , financial market , financial crisis , boom , financial market participants , financial economics , monetary economics , finance , macroeconomics , psychology , indirect finance , social psychology , environmental engineering , psychiatry , engineering

We model a financial market in which investor beliefs are shaped by representativeness. Investors overreact to a series of good news, because such a series is representative of a good state. A few bad news do not change investor minds because the good state is still representative, but enough bad news leads to a radical change in beliefs and a financial crisis. The model generates debt over-issuance, “this time is different” beliefs, neglect of tail risks, under- and over-reaction to information, boom-bust cycles, and excess volatility of prices in a unified psychological model of expectations.

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