Addressing the psychology of financial markets
The author suggests that the 2008 financial crisis was the culmination of an accelerating and inherently unstable process of financial market evolution. He argues that markets are not well organized to manage the power that financial assets have to generate emotion and their wider effect on human imagination and judgement, anchored in neurobiology. Judgements and decisions about risk, reward and the evaluation of success can become systematically compromised because the excitement of potential gain is disconnected from anxiety about potential consequences, producing groupthink and bubbles. When anxiety breaks through, a catastrophic loss of confidence is inevitable. In the aftermath the emotional pain that would be involved in accepting responsibility stands in the way of lessons being learned. The author's theoretical framework is influenced by modern psychoanalysis and draws on an interview study of international fund managers in 2007. He suggests that underlying psychological conflicts have influenced the way market institutions have evolved to compete by selling the promise of exceptional performance. To cope with the expectations upon them, agents are impelled to base their actions on stories which overvalue opportunities and underestimate risks; this creates agency issues and facilitates the process of disconnecting anxiety from excitement that creates bubble potential. Policy implications go well beyond improving regulation and transparency.
Volume (Year): 3 (2009)
Issue (Month): ()
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- Stefano DellaVigna, 2007.
"Psychology and Economics: Evidence from the Field,"
NBER Working Papers
13420, National Bureau of Economic Research, Inc.
- S. Dellavigna., 2011. "Psychology and Economics: Evidence from the Field," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 5.
- Stefano DellaVigna, 2009. "Psychology and Economics: Evidence from the Field," Journal of Economic Literature, American Economic Association, vol. 47(2), pages 315-72, June.
- S. Dellavigna., 2011. "Psychology and Economics: Evidence from the Field," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 4.
- Bechara, Antoine & Damasio, Antonio R., 2005. "The somatic marker hypothesis: A neural theory of economic decision," Games and Economic Behavior, Elsevier, vol. 52(2), pages 336-372, August.
- George A. Akerlof, 2009. "How Human Psychology Drives the Economy and Why It Matters," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 91(5), pages 1175-1175.
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