Neglected Risks: The Psychology of Financial Crises

12 Pages Posted: 27 Jan 2015 Last revised: 15 Jan 2023

See all articles by Nicola Gennaioli

Nicola Gennaioli

Bocconi University - Department of Finance

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Robert W. Vishny

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Date Written: January 2015

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.

Suggested Citation

Gennaioli, Nicola and Shleifer, Andrei and Vishny, Robert W., Neglected Risks: The Psychology of Financial Crises (January 2015). NBER Working Paper No. w20875, Available at SSRN: https://ssrn.com/abstract=2555395

Nicola Gennaioli (Contact Author)

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Andrei Shleifer

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-5046 (Phone)
617-496-1708 (Fax)

HOME PAGE: http://www.economics.harvard.edu/~ashleife/

National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI)

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Robert W. Vishny

University of Chicago - Booth School of Business ( email )

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United States
312-702-2522 (Phone)
312-702-0118 (Fax)

National Bureau of Economic Research (NBER)

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United States

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