Munich Personal RePEc strongArchivestrong - mpra.ub.uni-muenchen.de.pdf

MPRA 10/2/2007 Psychological Bias as a Driver of Financial Regulation* David Hirshleifer** 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 emphasizes 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. *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, 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. **Merage Chair in Business Growth and Professor of Finance, Merage School of Business, University of California, Irvine Key words: Investor psychology, regulation, salience, omission bias, scapegoating, xenophobia, fairness, reciprocity, norms, mood, availability cascades, overconfidence, evolutionary psychology, memes, ideology, replicators At a delightful dinner not long ago, a former president of the American Finance Association mentioned to me that as a behavioral financial economist, I should be a keen adv