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Psychological Bias as a Driver of Financial Regulation


  • Keynote address of the June 2007 European Financial Management Association Annual Meetings in Vienna, Austria. I thank Nick Barberis, Michael Brennan, James Choi, Stefano DellaVigna, John Doukas, Robin Keller, Antti Petajisto Andy Policano, Eric Rasmusen, Geert Rouwenhorst, Siew Hong Teoh, Sheridan Titman, and participants at the Yale University School of Management Finance Seminar and the Workshop on Psychology and Capital Markets at the Merage School of Business, UC Irvine for helpful discussion and comments.


I propose here the psychological attraction theory of financial regulation – that regulation is the result of psychological biases on the part of political participants – voters, politicians, bureaucrats, and media commentators; and of regulatory ideologies that exploit these biases. Some key elements of the psychological attraction approach are: salience and vividness, omission bias, scapegoating and xenophobia, fairness and reciprocity norms, overconfidence, and mood effects. This approach further emphasises emergent effects that arise from the interactions of individuals with psychological biases. For example, availability cascades and ideological replicators have powerful effects on regulatory outcomes.