Crisis of Beliefs

How investor expectations move markets and the economyThe collapse of Lehman Brothers in September 2008 caught markets and regulators by surprise. Although the government rushed to rescue other financial institutions from a similar fate after Lehman, it could not prevent the deepest recession in postwar history. A Crisis of Beliefs makes us rethink the financial crisis and the nature of economic risk. In this authoritative and comprehensive book, two of today’s most insightful economists reveal how our beliefs shape financial markets, lead to expansions of credit and leverage, and expose the economy to major risks.Nicola Gennaioli and Andrei Shleifer carefully walk readers through the unraveling of Lehman Brothers and the ensuing meltdown of the US financial system, and then present new evidence to illustrate the destabilizing role played by the beliefs of home buyers, investors, and regulators. Using the latest research in psychology and behavioral economics, they present a new theory of belief formation that explains why the financial crisis came as such a shock to so many people—and how financial and economic instability persist.A must-read for anyone seeking insights into financial markets, A Crisis of Beliefs shows how even the smartest market participants and regulators did not fully appreciate the extent of economic risk, and offers a new framework for understanding today’s unpredictable financial waters.

"One of Bloomberg's Best Books of 2018 (Cass Sunstein)", "One of Barron's Book Picks from Industry Leaders in 2018 (Robert Shiller)", "There is evidence from behavioral economics that people are not entirely logical, and do not actually rely fully on logic or standard statistical techniques. This behavioral economic perspective is embraced by Nicola Gennaioli of Bocconi University and Andrei Shleifer of Harvard University in their remarkable new book, A Crisis of Beliefs."---Robert J. Shiller, New York Times, "Economists are at last catching up with the seminal work of the late Hyman Minsky. In a book written for academics, but of wider relevance, the authors conclude that, first, investors make mistakes; second, those mistakes are systematic, predictable and incompatible with the view, that expectations are 'rational'; and, third, a new perspective, called 'diagnostic expectations', rooted in human psychology, does a good job of explaining these mistakes. Moreover, they argue, surveys indicate when expectations are becoming riskily euphoric and so should help predict crises."---Martin Wolf, Financial Times, "An ‘as smart as you would expect’ take on the hypothesis that investor over-extrapolation of recent price trends can cause financial crises, including our recent financial crisis."---Tyler Cowen, Marginal Revolution

Nicola Gennaioli is professor of finance at Bocconi University in Italy. He lives in Milan. Andrei Shleifer is professor of economics at Harvard University. His books include Inefficient Markets: An Introduction to Behavioral Finance and The Grabbing Hand: Government Pathologies and Their Cures. He lives in Newton, Massachusetts.