The bankruptcy of several European countries was not a bolt out of the blue. Nevertheless, recent economic developments have shaken Europe’s sense of security to the core. Tibor Neugebauer, Professor of Finance at the Luxembourg School of Finance, is specialised in behavioural finance, a science that seeks to explain the relationship between human behaviour and economics. In the following interview, he demonstrates how our daily life can be influenced by complex economic factors.
LFF: Seen from a psychological perspective: were there any developments during the euro crisis that could have been seen as predictable or even probable and yet still happened ?
TN: Indebtedness or over-indebtedness are always a big risk. It has been clear since the 1980s, for instance, that the Greek and Italian governments would have to refinance their national debt to a large extent. But what they could not foresee at that time was that we were going into a financial crisis in 2008.
Did investor behaviour change during the financial crisis?
The crisis caused a change in the risk appetite of investors and the refinancing of the dept has now become a real issue. Currently we are at a historical high in the risk premium. Volatility has increased and caused a capital flight to quality. Funds have been moved from high risk to low risk investments. These shifts have an affect on overall price levels and returns, so investors are withdrawing their money from their accounts and putting it into safer countries.
LFF: How closely are finance and society connected?
TN: Society, as reflected by politics, and finance can drive each other in a vicious circle. If the risk outlook for banks and financial institutions changes for the worse, that affects their ability to feed liquidity into the real economy. If the banks do not lend money to the real economy there will be no job creation. If confidence and perception of the future diminish, this of course affects people’s spending behaviour. This leads to a contraction in sales: companies produce less and unemployment increases. Fewer jobs cause an increase in poverty and public discontent threatens the re-election of politicians. Even democracy as a whole can be threatened, as the election of extremist movements becomes more likely.
Which is more important in the decision-making processes: opinion or facts?
Opinion plays a role in decision-making. Take for instance the “disposition effect”: both states and individuals hang on to assets that have dropped in value while selling shares that gained in value too early. But looking at the market as a whole, one cannot really differentiate between facts and opinions because the two intertwine to a great extent.
LFF: What do current social trends suggest about the future?
TN: There is tremendous capital flight by funds, for instance, out of Greece and Italy and that cause a shortage of money, which can ultimately cause unemployment and poverty in the long term. So one can say that people are becoming more focused on their own well-being and the welfare of their family. For that reason they are moving their financial assets to less risky places. Speaking in terms of the prospect theory of Kahneman & Tversky, loss aversion plays a major role. In Greece, for instance, there is a tradition whereby the elite leave the country once they have made their fortune. The keyword will be loyalty. The billionaire Warren Buffet, for instance, stated that he is willing to pay higher taxes. We need a similar kind of thinking all over the world.
LFF: What are your predictions concerning the area of behavioral finance in the future?
TN: During the financial crisis, there was increased interest in economics and behavioural economics as subjects. People who had never before been concerned with these kinds of topics suddenly became active in the field of research. In particular, the dynamics of crises became a focus of research, but I think there is a need for further empirical research in this field. There is only a limited possibility to do experiments in the real economic environment; therefore one should develop more laboratory research in behavioural finance.
LFF: How can behavioural finance contribute to the well being of the economy?
TN: We should not consider the financial market as a separate entity but rather a part of the economy as a whole. There is a need to provide tools to make good financial decisions at the level of central banks and decision-makers.