Irrational exuberance and deception — Why markets spin out of control

Abstract

This article reports on a field study of 457 US participants that identifies the intimate link between three constructs: disconnection (dis-anchoring) from the bundle of needs, goals, and preferences (NGPs), irrationality, and indebtedness. We combine these three mental states that together influence deceitful borrowing behaviors to define irrational exuberance. When using linear regressions and path analyses, we find that together they form a self-reinforcing wheel of misfortune that may spin out of control and generate market frictions, as suggested by US market data. A predatory dynamic drives this loop whereby market agents position themselves at various levels of financial predation (as either predators, prey, or a mix thereof). The theoretical implications of our findings are that we integrate this loop into the literature on debt, something that has not been done before in financial or economic theory. Thus, we enrich the understanding of why market agents – lenders and borrowers alike, either individuals or organizations – mislead each other and why markets consequently tend to deviate from normalcy. The managerial implication is that a better psychological appraisal of borrowers’ mental states and behaviors would likely improve lending risk assessment, may reduce default outcomes, and, on a macroeconomic level, could alleviate the symptoms of impending financial crises.