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Markets may play jilted lover in euro zone drama

Emotional Finance: Behavioral economists say financial bubbles can create a deep emotional low when it pops

Written by Reuters | London |
December 20, 2011 1:36:14 am

The euro zone debt crisis may be as much about the heart as it is about the head — like a jilted lover,markets are just finding it hard to trust again.

Behavioral economists say financial bubbles can create an emotional high that turns into a irrationally deep low when the bubble pops — people begin to ignore fundamentals and have only negative associations with certain investments.

“Something like that is now happening with the euro (zone) where it has become contaminated on a psychological level and hated,” said David Tuckett,psychoanalyst and author of Minding the Markets.

“It actually is quite a good analogy to think of if your girlfriend has an affair or something. It’s actually very difficult to get back (together),although it can be done.”

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Tuckett and other proponents of “emotional finance” — the intersection of managerial finance and investor psychology — say in periods of crisis following sustained growth,fear and panic can spread like a virus.

“Sometimes just a little trigger,quite often trivial,can lead to a tipping point unraveling the whole thing usually very quickly. It starts moving in one direction,then panic takes over … basically driven by herding behavior,” said Paul de Grauwe,professor of international economics at the University of Leuven and an expert on monetary union and European debt.

In the case of the euro,the prospect of Greek default was enough to take Greece’s debt problems off years of slow boil and eventually prompt Europe to think the unthinkable — breaking up the euro zone.

To emotional finance experts this makes sense; like the example of the troubled relationship,at a certain point everything associated with a former love begins to seem tainted. Emotions are a way people can tip the scales in a dilemma between two unknowns,and changes in these emotional states drive events like the euro zone crisis,Tuckett said.

“In order to make decisions in a world of uncertainty,if it’s falling in love with something or making a big investment or buying a house,your emotions have to be engaged in that decision because it cannot be done on rational grounds alone.”

“There was euphoria about the euro zone like there was during the bubble in the 1990s — people didn’t see the weaknesses,” said de Grauwe,author of the authoritative “Economics of Monetary Union” textbook.

“When you are euphoric you are blind. It’s like being in love — you are blind.”

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