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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

(p.15) 2 Psychology and the Financial Crisis of 2007–2008
Financial Innovation

Michael Haliassos

The MIT Press

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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