Psychological Bias as a Driver of Financial Regulation

David Hirshleifer

European Financial Management, November 2008


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.

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