Exploring Investors' Decision Making Processes During the 2008 Financial Crisis Using Epstein's Cognitive Experiential Self-Theory: A Multiple-case Study

Abstract

A longstanding controversy in financial economics is whether investors' rational forces or their emotional responses govern the asset pricing of the financial markets. Some psychology researchers use dual- process models to understand peoples' information processing. The problem is that some investors allow cognitive biases which operate quickly and automatically in the System 1 domain, to affect their decisions rather than respond deliberatively and rationally which are ascribed to the System 2 domain. The purpose of this study was to explore how and why investors, when faced with extreme stress impelled during the 2008 Financial Crisis, yielded to either System 1 or System 2 axis decision-making. Without evaluating the role that cognitive biases play in information processing, investors will not understand why they make inauspicious automatic decisions or grasp the steps that could help avoid realized losses in their stock portfolio. This qualitative research consisted of a multiple-case study that included in-depth semi-structured interviews of 12 investors who had at least $1 million invested in stocks and bonds and triangulation data analysis. The research findings indicated that stock market literacy and risk profiling are foundations for sound investing. When faced with a financial crisis, some investors displayed cognitive biases such as nervousness, worry, and fear that led to myopic loss aversion that caused them to sell their entire stock portfolio or reallocated into more conservative, less risky bonds. Some investors with no emotions and higher stock market literacy considered the financial crisis as a blip in the long-term upward trend performance of stocks and viewed the financial crisis as an opportunity to buy more stocks. For those investors that displayed emotions because of the financial crisis, emotion regulation strategies helped them make more controlled and deliberative investment decisions. Nevertheless, the decisions made by investors may be satisficing because of peoples' bounded rationality, the inherent information processing limitation of the human mind. The specific role of emotion in the duality of information processing was undetermined because the crisis evolved over time rather than a singular event. It is possible that quantitative determination of stock market literacy and the application of Epstein's Rational-Experiential Questionnaire and personality tests including satisfaction questions could shed further information on the dual-process mechanisms.

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