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Neglected Risks: The Psychology of Financial Crises

Author

Listed:
  • Nicola Gennaioli
  • Andrei Shleifer
  • Robert Vishny

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.
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Suggested Citation

  • Nicola Gennaioli & Andrei Shleifer & Robert Vishny, "undated". "Neglected Risks: The Psychology of Financial Crises," Working Paper 256166, Harvard University OpenScholar.
    • Handle: RePEc:qsh:wpaper:256166
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    File URL: http://scholar.harvard.edu/shleifer/node/256166
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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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