Trust and Risk Aversion in the Aftermath of the Great Recession

Abstract

The financial crisis has impacted enormously on two features that are critical for investors' decisions: their beliefs and their preferences. It has brought to light diffuse opportunistic behaviour and some serious frauds. Because of this, trust in banks, bankers and brokers and the stock market has collapsed to unprecedented levels. The fear following the crisis, and the symptoms of panic that went with it, have led investors to become much more risk averse than they used to be in the past. We argue that failing trust and risk tolerance have a major effect on the working of financial markets and the economy. We show evidence that suggests that the drop in trust and the increase in risk aversion are likely to be enduring and very slow to recover. This is one reason, perhaps among others, why the consequences of the financial crisis will probably be lasting.