A Crisis of Beliefs

Nicola Gennaioli; Andrei Shleifer

Published by Princeton University Press 2018

A Crisis of Beliefs

Investor Psychology and Financial Fragility

Nicola Gennaioli and Andrei Shleifer

https://doi.org/10.23943/9780691184920

Overview
Contents

About this book

How investor expectations move markets and the economy

The collapse of Lehman Brothers in September 2008 caught markets and regulators by surprise. Although the government rushed to rescue other financial institutions from a similar fate after Lehman, it could not prevent the deepest recession in postwar history. A Crisis of Beliefs makes us rethink the financial crisis and the nature of economic risk. In this authoritative and comprehensive book, two of today’s most insightful economists reveal how our beliefs shape financial markets, lead to expansions of credit and leverage, and expose the economy to major risks.

Nicola Gennaioli and Andrei Shleifer carefully walk readers through the unraveling of Lehman Brothers and the ensuing meltdown of the US financial system, and then present new evidence to illustrate the destabilizing role played by the beliefs of home buyers, investors, and regulators. Using the latest research in psychology and behavioral economics, they present a new theory of belief formation that explains why the financial crisis came as such a shock to so many people—and how financial and economic instability persist.

A must-read for anyone seeking insights into financial markets, A Crisis of Beliefs shows how even the smartest market participants and regulators did not fully appreciate the extent of economic risk, and offers a new framework for understanding today’s unpredictable financial waters.

Author information

Nicola Gennaioli is professor of finance at Bocconi University in Italy. He lives in Milan. Andrei Shleifer is professor of economics at Harvard University. His books include Inefficient Markets: An Introduction to Behavioral Finance and The Grabbing Hand: Government Pathologies and Their Cures. He lives in Newton, Massachusetts.

Reviews

"What caused the financial crisis of 2008? What’s likely to cause future crises? Gennaioli and Shleifer offer an original, compelling and intriguing answer: investor psychology. . . . Gennaioli and Shleifer offer a parsimonious account of boom-bust cycles — one that relies mostly on what goes on in people’s minds."---Cass Sunstein, Bloomberg

"For a decade now, people have been looking for a silver lining to the disasters of 2008-2018, hoping that this period will bring about a more productive integration of finance, behavioral economics, and macroeconomic orthodoxy. So far, they have been searching in vain. But with the publication of A Crisis of Beliefs, there is hope yet."---J. Bradford Delong, Project Syndicate

"Something is wrong with the economics profession if events like those of 2008 do not change its thinking. Those wanting to be in the vanguard of the new thinking should be reading A Crisis of Beliefs."---Lawrence Summers, WashingtonPost.com's Wonkblog

"There is evidence from behavioral economics that people are not entirely logical, and do not actually rely fully on logic or standard statistical techniques. This behavioral economic perspective is embraced by Nicola Gennaioli of Bocconi University and Andrei Shleifer of Harvard University in their remarkable new book, A Crisis of Beliefs."---Robert J. Shiller, New York Times

"Economists are at last catching up with the seminal work of the late Hyman Minsky. In a book written for academics, but of wider relevance, the authors conclude that, first, investors make mistakes; second, those mistakes are systematic, predictable and incompatible with the view, that expectations are 'rational'; and, third, a new perspective, called 'diagnostic expectations', rooted in human psychology, does a good job of explaining these mistakes. Moreover, they argue, surveys indicate when expectations are becoming riskily euphoric and so should help predict crises."---Martin Wolf, Financial Times

"A decade after the financial crisis of 2008 and its aftermath, economists are still grappling with its nature and significance. An important recent contribution is A Crisis of Beliefs. . . . They make a convincing case for taking seriously the evidence provided by surveys and anecdotes that characterize the beliefs held at the time by households, investors, and policy makers."---Arnold Kling, EconLib

"One of Bloomberg's Best Books of 2018 (Cass Sunstein)"

"One of Barron's Book Picks from Industry Leaders in 2018 (Robert Shiller)"

"An ‘as smart as you would expect’ take on the hypothesis that investor over-extrapolation of recent price trends can cause financial crises, including our recent financial crisis."---Tyler Cowen, Marginal Revolution

Topics

Frontmatter Publicly Available Download PDF	i
CONTENTS Publicly Available Download PDF	vii
ACKNOWLEDGMENTS Requires Authentication Unlicensed Licensed Download PDF	ix
Introduction Requires Authentication Unlicensed Licensed Download PDF	1
CHAPTER 1 The Financial Crisis of 2008 Requires Authentication Unlicensed Licensed Download PDF	21
CHAPTER 2 What Were They Thinking? Requires Authentication Unlicensed Licensed Download PDF	49
CHAPTER 3 A Neglected Risk Model of the Financial Crisis Requires Authentication Unlicensed Licensed Download PDF	79
CHAPTER 4 Extrapolation in Financial Markets Requires Authentication Unlicensed Licensed Download PDF	107
CHAPTER 5 Representativeness and Diagnostic Beliefs Requires Authentication Unlicensed Licensed Download PDF	137
CHAPTER 6 Diagnostic Expectations and Credit Cycles Requires Authentication Unlicensed Licensed Download PDF	167
CHAPTER 7 Open Problems Requires Authentication Unlicensed Licensed Download PDF	193
Appendix: Proofs Requires Authentication Unlicensed Licensed Download PDF	207
References Requires Authentication Unlicensed Licensed Download PDF	231
Index Requires Authentication Unlicensed Licensed Download PDF	245