TY - UNPB

T1 - Visceral emotions, within-community communication, and (ill-judged) endorsement of financial propositions

AU - Kaivanto, Kim

PY - 2014

Y1 - 2014

N2 - The 2007-08 financial crisis exposed poignant examples of ill-judged risk accretion in both tails of the Lorenz curve: concentrations of inappropriate mortgages within low-income neighborhoods, and concentrations of Bernard Madoff’s victims within wealthy, predominantly Jewish country-club communities. These examples share three key elements. First, individual behavioural decision makers take decisions privately but contribute to the build-up of risk within the community. Second, sales agents employ psychological persuasion techniques (bypassing logical processes), and trigger visceral emotions (overriding rational deliberation). Third, community membership immerses individuals within information flows that trigger invidious visceral emotions, and leads to biased inferences due to sample-size illusion and persuasion bias. We develop a closed-form model based on Signal-Detection Theory (SDT) that incorporates all three abovementioned elements: it is behavioral in employing a Prospect Theory (PT) objective function; peripheral-route persuasion and visceral emotions are incorporated through their impacts on discriminability d′; and sample-size illusion and persuasion bias are incorporated through their effects on the score θ. This PT-SDT model predicts that visceral-emotion-charged hot states can short-circuit the capacity to practice caveat emptor, carrying implications for regulation and for our understanding of US household-borrowing growth 2001–2006.

AB - The 2007-08 financial crisis exposed poignant examples of ill-judged risk accretion in both tails of the Lorenz curve: concentrations of inappropriate mortgages within low-income neighborhoods, and concentrations of Bernard Madoff’s victims within wealthy, predominantly Jewish country-club communities. These examples share three key elements. First, individual behavioural decision makers take decisions privately but contribute to the build-up of risk within the community. Second, sales agents employ psychological persuasion techniques (bypassing logical processes), and trigger visceral emotions (overriding rational deliberation). Third, community membership immerses individuals within information flows that trigger invidious visceral emotions, and leads to biased inferences due to sample-size illusion and persuasion bias. We develop a closed-form model based on Signal-Detection Theory (SDT) that incorporates all three abovementioned elements: it is behavioral in employing a Prospect Theory (PT) objective function; peripheral-route persuasion and visceral emotions are incorporated through their impacts on discriminability d′; and sample-size illusion and persuasion bias are incorporated through their effects on the score θ. This PT-SDT model predicts that visceral-emotion-charged hot states can short-circuit the capacity to practice caveat emptor, carrying implications for regulation and for our understanding of US household-borrowing growth 2001–2006.

KW - within-community risk accretion

KW - signal detection theory

KW - prospect theory

KW - psychology of deception

KW - peripheral-route persuasion

KW - visceral emotions

KW - persuasion bias

KW - mortgage mis-selling

KW - predatory lending

KW - Madoff ponzi scheme

KW - caveat emptor

KW - accredited investor status

M3 - Working paper

T3 - Economics Working Paper Series

BT - Visceral emotions, within-community communication, and (ill-judged) endorsement of financial propositions

PB - Lancaster University, Department of Economics

CY - Lancaster

ER -