Psychology and the Financial Crisis of 2007-2008

16 Pages Posted: 18 Jan 2011 Last revised: 3 Sep 2011

Nicholas Barberis

Yale School of Management; National Bureau of Economic Research (NBER)

Date Written: August 1, 2011

Abstract

I discuss some ways in which ideas from psychology may be helpful for thinking about the financial crisis of 2007-2008. I focus on three aspects of the crisis: the surge in house prices in the years leading up to 2006; the large positions in subprime-linked securities that many banks had accumulated by 2007; and the dramatic decline in value of many risky asset classes during the crisis period. I review a number of psychology-based mechanisms, but emphasize two, both of which have already been extensively studied in behavioral finance and behavioral economics: over-extrapolation of past price changes; and belief manipulation.

Keywords: financial crisis, psychology, extrapolation, belief manipulation

JEL Classification: G12, G21

Suggested Citation

Barberis, Nicholas, Psychology and the Financial Crisis of 2007-2008 (August 1, 2011). Available at SSRN: https://ssrn.com/abstract=1742463 or http://dx.doi.org/10.2139/ssrn.1742463

Nicholas Barberis (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-436-0777 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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