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  3. American Economic Review
  4. May 2015
  5. Neglected Risks: The Psychology of Financial Crises

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Neglected Risks: The Psychology of Financial Crises

  • Nicola Gennaioli
  • Andrei Shleifer
  • Robert Vishny
American Economic Review
vol. 105, no. 5, May 2015
(pp. 310–14)
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Abstract

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.

Citation

Gennaioli, Nicola, Andrei Shleifer, and Robert Vishny. 2015. "Neglected Risks: The Psychology of Financial Crises." American Economic Review 105 (5): 310–14. DOI: 10.1257/aer.p20151091

Additional Materials

JEL Classification

  • D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
  • D84 Expectations; Speculations
  • E32 Business Fluctuations; Cycles
  • E44 Financial Markets and the Macroeconomy
  • G01 Financial Crises