Psychology, Financial Decision Making, and Financial Crises

Tommy Gärling, Erich Kirchler, Alan Lewis, and Fred van Raaij
How could the current financial crisis have happened? While fingers have been pointing to greedy banks, subprime-loan officers, and sloppy credit card practices, these are not the only contributors to the economic downturn. A new report examines the psychology of financial decision making, including the role of risk in making economic choices, how individuals behave in stock and credit markets, and how financial crises impact people’s well-being.
Risk taking is a very important component of financial decision making — If we take out a big loan, will we be able to pay it back? Should we buy shares of a company that is unknown but has potential for great success? When it comes to making decisions under uncertainty, people tend to be more influenced by perceived risk than by objective risk. People who are extraverted and high in sensation seeking are likelier to take more and higher financial risks than are people high in conscientiousness and anxiety. Stock market investors are prone to cognitive biases (such as overconfidence), which are reinforced by affective and social influences, and these may contribute to several phenomena observed in stock markets (e.g., volatility of stock prices due to excessive trading). Credit use involves many different stages of decision making, including deciding whether or not to purchase a product using credit and determining a strategy for paying back the borrowed money.
Financial crises take a large toll not just on peopleR...