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Neglected Risks: The Psychology of Financial Crises

Nicola Gennaioli, Andrei Shleifer, Robert Vishny

NBER Working Paper No. 20875
Issued in January 2015
NBER Program(s):The Asset Pricing Program, The Corporate Finance Program

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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Document Object Identifier (DOI): 10.3386/w20875

Published: Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2015. "Neglected Risks: The Psychology of Financial Crises," American Economic Review, American Economic Association, vol. 105(5), pages 310-14, May. citation courtesy of

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