Ulric B. and Evelyn L. Bray Seminar

Tail risk is pervasive in financial markets. Overlooking it often leads to blow-ups. Here I consider assets that yield steady streams of good payoffs but eventually inflict a major loss, leading the investor to blow up.  Learning about those assets' risk/reward profiles is crucial yet challenging. When asked to perform a stylized version of the task, participants managed to learn in a Bayesian way. However, many still chose to invest in these assets, apparently owing to an overwhelming desire to pick pennies. These findings may help flesh out key psychological forces at stake during financial manias.