Behavioral Finance and COVID-19: Cognitive Errors that Determine the Financial Future

Abstract

The COVID-19 pandemic has resulted in dramatic economic effects, characterized by excessive stock price volatility and a market crash. Some of the phenomena in effect during the crisis, such as the excessive volatility and the unshaken confidence of financial institutions, are insufficiently explained by the traditional finance paradigm. In this paper, we explore such phenomena from a behavioral finance lens and discuss some cognitive errors and biases relevant during and after the crisis - overconfidence (miscalibration, better-than-average effect, illusion of control, optimism bias), representation bias, risk aversion, herding behavior, and availability bias. We explore each of these phenomena from the perspective of psychology and evaluate their relevance to financial institutions and markets and the COVID-19 induced global crisis.