How Psychological Pitfalls Generated the Global Financial Crisis

Abstract

The root cause of the financial crisis that erupted in 2008 is psychological. In the events which led up to the crisis, heuristics, biases, and framing effects strongly influenced the judgments and decisions of financial firms, rating agencies, elected officials, government regulators, and institutional investors. Among the many lessons to be learned from the crisis is the importance of focusing on the behavioral aspects of business process. Examples involving UBS, Merrill Lynch, Citigroup, Standard & Poor’s, and the SEC illustrate this point. The examples provide support for a position arguing behavioral finance needs to be much better integrated into business school education. The extent of process failure prior to the crisis suggests when it comes to integrative education, behavioral corporate finance is especially germane.