This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

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

Neglected Risks: The Psychology of Financial Crises

Download Full Text PDF

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