Choice Review

The crisis of the title refers, principally, to the financial crisis of 2008; beliefs represents the expectations of those involved in the crisis, beliefs often at odds with reality. Building on the behavioral research of Daniel Kahneman and Amos Tversky, Gennaioli (Bocconi Univ., Italy) and Shleifer (Harvard) offer a psychological interpretation of the evolution of those beliefs and their consequences. The first chapter reprises the 2008 crisis, placing particular emphasis on the Lehman bankruptcy. Prior to Lehman, the authors argue, the risk of financial collapse was underestimated. Following Lehman, however, the market expectations became unduly pessimistic, resulting in fire sales of financial assets. To explain this evolution of beliefs from irrational optimism to irrational pessimism, the authors employ Kahneman and Tversky's concept of representativeness. Specific financial news is believed to be representative, more broadly, of good financial circumstances. The kernel of truth embodied in the specific news encourages the diagnosis of favorable economic conditions generally. The reverse can be expected in response to bad news. This approach--diagnostic expectations--stands in contrast to the traditional rational expectations interpretations. The fundamental crisis of beliefs, the authors conclude, may be the enduring belief of economists in rational expectations. Summing Up: Recommended. Upper-division undergraduates through faculty. --Roger S. Hewett, emeritus, Drake University