Featured Research

from universities, journals, and other organizations

The psychology of financial decision making and economic crises

Date:
September 22, 2010
Source:
Association for Psychological Science
Summary:
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.

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 in Psychological Science in the Public Interest, a journal of the Association for Psychological Science, 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.

Related Articles


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? In this report, authors Tommy Gδrling (University of Gothenberg, Sweden), Erich Kirchler (University of Vienna, Austria), Alan Lewis (University of Bath, UK), and Fred van Raaij (Tilburg University, The Netherlands) note that 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. "The general implication is that financial crises may have more serious consequences for people who are more likely to take financial risks," write the authors.

Efficient-market theory states that stocks should always be traded based on their real value. However, 5 minutes on the floor of the New York Stock Exchange reveals a different reality: Stock investors overreact to news (especially of events that threaten the world economy), selling winning stocks too soon while hanging on to losing stocks too long, and following other traders' leads in buying and selling stocks. According to Gδrling and his colleagues, 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).

Many people rely on credit, not just the plastic card kind, but also in the form of automobile financing and loans from friends. 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. The authors observe that "many credit users are facing a complex task when they decide to take up credit and that they often fall prey to cognitive errors when anticipating their experiences with credit payback."

Financial crises take a large toll not only on people's wallets, but also on their behavior. Consumer confidence affects spending and saving. Individuals cope with financial crises in a number of ways, for example by shopping in cheaper stores and eating out less. Making lifestyle changes (e.g., selling the car, making their own clothing) is very difficult for most people and is often a last resort to dealing with economic troubles-these changes clearly signal to themselves and others that they are struggling financially.

Are financial crises inevitable? The authors argue that bringing about change in financial institutions may not be easy, but they offer suggestions for improving economic decision making. For example, educating consumers -- by offering economics courses to children in school and teaching consumers how to appropriately handle credit -- and by making financial institutions more responsible (e.g., banks offering Web-based programs to assist with budgeting).

The article is entitled, "Psychology, Financial Decision Making, and Financial Crises."


Story Source:

The above story is based on materials provided by Association for Psychological Science. Note: Materials may be edited for content and length.


Cite This Page:

Association for Psychological Science. "The psychology of financial decision making and economic crises." ScienceDaily. ScienceDaily, 22 September 2010. <www.sciencedaily.com/releases/2010/09/100922111428.htm>.
Association for Psychological Science. (2010, September 22). The psychology of financial decision making and economic crises. ScienceDaily. Retrieved October 24, 2014 from www.sciencedaily.com/releases/2010/09/100922111428.htm
Association for Psychological Science. "The psychology of financial decision making and economic crises." ScienceDaily. www.sciencedaily.com/releases/2010/09/100922111428.htm (accessed October 24, 2014).

Share This



More Mind & Brain News

Friday, October 24, 2014

Featured Research

from universities, journals, and other organizations


Featured Videos

from AP, Reuters, AFP, and other news services

Academic Scandal Shocks UNC

Academic Scandal Shocks UNC

AP (Oct. 23, 2014) — A scandal involving bogus classes and inflated grades at the University of North Carolina was bigger than previously reported, a new investigation found. (Oct. 23) Video provided by AP
Powered by NewsLook.com
Working Mother Getaway: Beaches Turks & Caicos

Working Mother Getaway: Beaches Turks & Caicos

Working Mother (Oct. 22, 2014) — Feast your eyes on this gorgeous family-friendly resort. Video provided by Working Mother
Powered by NewsLook.com
What Your Favorite Color Says About You

What Your Favorite Color Says About You

Buzz60 (Oct. 22, 2014) — We all have one color we love to wear, and believe it or not, your color preference may reveal some of your character traits. In celebration of National Color Day, Krystin Goodwin (@kyrstingoodwin) highlights what your favorite colors may say about you. Video provided by Buzz60
Powered by NewsLook.com
First-Of-Its-Kind Treatment Gives Man Ability To Walk Again

First-Of-Its-Kind Treatment Gives Man Ability To Walk Again

Newsy (Oct. 21, 2014) — A medical team has for the first time given a man the ability to walk again after transplanting cells from his brain onto his severed spinal cord. Video provided by Newsy
Powered by NewsLook.com

Search ScienceDaily

Number of stories in archives: 140,361

Find with keyword(s):
 
Enter a keyword or phrase to search ScienceDaily for related topics and research stories.

Save/Print:
Share:  

Breaking News:

Strange & Offbeat Stories

 

Health & Medicine

Mind & Brain

Living & Well

In Other News

... from NewsDaily.com

Science News

Health News

Environment News

Technology News



Save/Print:
Share:  

Free Subscriptions


Get the latest science news with ScienceDaily's free email newsletters, updated daily and weekly. Or view hourly updated newsfeeds in your RSS reader:

Get Social & Mobile


Keep up to date with the latest news from ScienceDaily via social networks and mobile apps:

Have Feedback?


Tell us what you think of ScienceDaily -- we welcome both positive and negative comments. Have any problems using the site? Questions?
Mobile iPhone Android Web
Follow Facebook Twitter Google+
Subscribe RSS Feeds Email Newsletters
Latest Headlines Health & Medicine Mind & Brain Space & Time Matter & Energy Computers & Math Plants & Animals Earth & Climate Fossils & Ruins