Showing posts from March, 2014

Role of Psychology in the financial crisis of 2007-2008

This Subject interests me and hence i thought of putting this blog here.

Psychology played a critical role in explaining the “irrational behavior” of various financial institution entities which might have led to the subprime crisis of 2007-2008. this is a summary written on original  paper  by Nicholas Barberis. Surge in the housing Prices: The growth of the bubble can be attributed to the belief based theory of overvaluation where investors extrapolate past outcomes. Here in this case, the prior growth in housing price made the buyers believe that the growth will continue and bought houses with excessive loan to asset value ratio. Similarly, the financiers believed in the housing prices growth story and provided oversupply of subprime loans to buyers. These loans were securitized by complex financial innovations and sold to investors.  Here, this belief theory of extrapolation had its greatest impact where the security rating agency awarded risky assets with higher secure ratings. A…

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