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Financial InnovationToo Much or Too Little?$
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Michael Haliassos

Print publication date: 2013

Print ISBN-13: 9780262018296

Published to MIT Press Scholarship Online: January 2015

DOI: 10.7551/mitpress/9780262018296.001.0001

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Psychology and the Financial Crisis of 2007–2008

Psychology and the Financial Crisis of 2007–2008

Chapter:
(p.15) 2 Psychology and the Financial Crisis of 2007–2008
Source:
Financial Innovation
Author(s):

Michael Haliassos

Publisher:
The MIT Press
DOI:10.7551/mitpress/9780262018296.003.0002

This chapter presents some ways in which ideas from psychology may be helpful for thinking about the financial crisis of 2007-2008. It focuses 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. The paper reviews a number of psychology-based mechanisms, but emphasizes 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, Extrapolation, Bubble, Dissonance

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