Financial Crisis

Essay by manixxxxx April 2014

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Psychology and the financial crisis of 2007-2008

In the paper of Nicholas Barberis we see some main ideas show psychology can be helpful in time of financial crisis.He focuses on three aspects of the crisis and shows us a number of psychology based mechanisms, but stresses on two of them, both of which have already been extensively studied: over-extrapolation of past price changes and belief manipulation.

One of the main ideas Nicholas Barberis that wanted to share with us is if behavioral finance can offer a useful perspective on the financial crisis of 2007-2008 and can ideas extracted from psychology help us to make understand the crisis.

A central element in many discussions of the financial crisis is the idea that there was a real-estate bubble, due to different reasons. Many commentators are strongly convinces that there was such a phenomena .

There a different theories about the asset market evaluation but generally these theories can be categorized based on whether they focus on investor beliefs or on investor preferences.

The most useful model for understanding the recent behavior model of the real estate market is one of the belief-based models: the model that when bubble occurs because, due to representativeness heuristic, people over-extrapolate the past when making forecasts about the future. On one level we can say that because of this way of thinking, when forecasting the future growth in house prices the people over-extrapolated the past growth in these prices.

The belief manipulation hypothesis can be through of as an ''alternative to the bad incentives'' , ''bad models'' and ''bad luck '' views. But actually the belief manipulation tries to explain why traders are unaware of the risks they are taking. One the features of the crisis was that during it and its period many king of...