Role of Psychology in the financial crisis of 2007-2008

Representative Image
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. All this contributed to the surge in the asset prices.
Large Positions held by Banks in Sub Prime Linked Securities:
Manipulation of beliefs played a critical role in thwarting the cognitive dissonance which the various players (mortgage officials) would have felt while exposing the financial institutions to the high risked subprime linked assets. The complexity of the financial structure of these assets enabled them to manipulate their thought process through “bad incentives” - where they were incentivized to go for high growth funds and “bad models”  - where they modeled the financial future outflow to be a high growth one  and ignored the riskiness of the assets. Similar logic can be attributed to the security agencies which also gave higher ratings to these risky assets. Manipulation of belief ensured than Bank had great exposure to Sub Prime Linked Securities.
Dramatic Decline in the asset value:
With all confusion around the surprising and confusing developments in the market for subprime-linked securities, Investors including banks felt less competent while analyzing the subprime related assets as they incurred the initial losses in the risky assets.  This made them more ambiguity averse, leading them to reduce their holdings of risky assets, thereby further lowering the prices of these assets. Also the loss aversion amongst the investor increased as they incurred the initial losses which made them sell off the risky assets starting a downward spiral of asset values.
Belief based theories like Over Extrapolation over past experiences, Manipulation of beliefs to thwart cognitive dissonance and Ambiguity and Loss Aversions played a critical part in explaining all the 3 stages of the financial crisis – Surge in the housing prices, large positions held by Banks in subprime Linked Securities and Dramatic Decline in the asset values.

 Do let me know your thoughts on this.

Comments

  1. Great explanation of what resulted in the housing bubble and burst. IMHO though, human psychology is not a reason but THE fundamental reason behind each bubble and burst cycle. There may be different classes or parts of society that contribute to the bubble each time but at the core its always irrational greed followed by irrational fear. Our own real estate market is good case in point where people expect that it can never go down and at most just stay stagnant. Wouln't everyone in the world want to part their money in a marke like that :D

    ReplyDelete
  2. But somebody somewhere should do their job properly to curb this extrapolation.......systemic failure and we land ourselves into another mess......

    ReplyDelete
  3. Oracle fusion Financials Training from CALFRE.COM gives you the best results to learn your dream course and maintains sufficient knowledge on oracle. It provides training by self-paced videos which are very helpful for the users to watch at any time according to their schedule. It is globally accepted and having many users undergoing training every day.



    Oracle fusion Financials Training in hyderabad

    Oracle Fusion Financials online Training in hyderabad

    ReplyDelete
  4. All this contributed to the surge in the asset prices.https://liedetectortest.uk

    ReplyDelete
  5. It serves as a guide for students with tips such as reasons to major in psychology, academic success stories and available careers for psychology majors. write a perfect dissertation

    ReplyDelete
  6. This comment has been removed by the author.

    ReplyDelete
  7. This comment has been removed by the author.

    ReplyDelete
  8. During the time spent this present advance's development, a positive relations are shaped between a bank (the credit is given by a juridical of physical individual, who gives certain money as an obligation) and the account holder. vizualize.me/ChuckRobertsStifel

    ReplyDelete
  9. accept it, and begin to practice it, the sooner you will be free from feeling controlled by anyone else click here

    ReplyDelete
  10. This is such a great resource that you are providing and you give it away for free. I love seeing blog that understand the value of providing a quality resource for free. Biografia de Sigmund Freud

    ReplyDelete
  11. Really enjoyed this blog post.Really looking forward to read more. Want more. best quotes

    ReplyDelete
  12. The problem is, of course, that it is in the adviser's interest that we make as many trades as possible and there may be an almost irresistible temptation for pay-per-trade advisers to encourage us to churn our investments - constantly buying and selling - so they can make money,https://mailchi.mp/cc08635ff53e/solopreneursguide rather than advising us to leave our money for several years in particular shares, unit trusts or other financial products.

    ReplyDelete
  13. It’s appropriate time to make some plans for the future and it is time to be happy. I have read this post and if I could I wish to suggest you few interesting things or advice. Perhaps you could write next articles referring to this article. I desire to read even more things about it! eğitim psikoloji

    ReplyDelete
  14. I found your website perfect for my needs. It contains wonderful and helpful posts. dubai islamic bank car financing calculator - abl car loan

    ReplyDelete
  15. Thanks for picking out the time to discuss this, I feel great about it and love studying more on this topic. It is extremely helpful for me. Thanks for such a valuable help again. KETQUAMOINHAT

    ReplyDelete
  16. Thanks for an interesting blog. What else may I get that sort of info written in such a perfect approach? I have an undertaking that I am just now operating on, and I have been on the lookout for such info. 파워볼 안전사이트

    ReplyDelete
  17. This program also can export or convert audio from DVD, MPEG, MP4, AVI, DIVX, MOV, WMV, VOB, 3GP, RM, QT, FLV, and other video files also provides a modern interface for users. You also know that the output directory is not changed. You give them input and it works on your input and gives you output.https://fullmaccrack.com/avs-audio-converter-crack-activation-key/ .

    ReplyDelete
  18. Great survey, I'm sure you're getting a great response. csgo ranking system

    ReplyDelete
  19. """Welcome to We Buy Houses Fort Lauderdale, the Official Cash Home Buyer of Fort Lauderdale, Florida, and surrounding areas.

    We provide home sellers with a cash option to purchase their property quickly—with NO Repairs, and NO Fees or Commissions. Simply go to our website or call us at (754) 200-2005 to get a no-obligation cash home offer sent to you. It’s free and confidential.

    Avoiding foreclosure? Facing divorce? Moving? Upside down in your mortgage? Liens? It doesn’t matter whether you live in it, you’re renting it out, it’s vacant, or not even habitable. We help owners who have inherited an unwanted property, own a vacant house, are behind on payments, owe liens, downsized, and can’t sell… even if the house needs repairs that you can’t pay for… and yes, even if the house is fire damaged or has bad rental tenants. Basically, if you have a property and need to sell it… we’d like to make you a fair cash offer and close on it when you’re ready to sell.

    Just contact us today to get started!"""

    ReplyDelete
  20. You wrote this post very carefully. The amount of information is stunning and also a gainful article for us. Keep sharing this kind of articles, Thank you.Mutual Fund Service Providers Gorakhpur

    ReplyDelete
  21. It's an article that benefits us and has an amazing amount of information. Continue posting articles of this nature. Commercial Construction in Trivandrum

    ReplyDelete

Post a Comment

Popular posts from this blog

Email Marketing Quick Trick : How to create a click to post

A MOOC Review : What Can Blockchain Do for you?