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

Kim Kaivanto

No 69123498, Working Papers from Lancaster University Management School, Economics Department

Abstract: 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.

Keywords: within-community risk accretion; signal detection theory; prospect theory; psychology of deception; peripheral-route persuasion; visceral emotions; persuasion bias; mortgage mis-selling; predatory lending; Madoff ponzi scheme; caveat emptor; accredited investor status (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-cbe and nep-neu
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