Book Review: A Crisis of Beliefs - Nicola Gennaioli and Andrei Shleifer

One of the first concerns I had to contend with before putting a considerable portion of my life savings into the stock market was the potential for market downturns. Having lived through the GFC, I was keen to have an understanding of the factors that lead to the last market crash, which is why "A Crisis of Beliefs" by Nicola Gennaioli and Andrei Shleifer caught my eye, so I had to check it out (✧ω✧) .

Basically the book creates a fairly complex mathematical model demonstrating how a failure to consider the downside risk coupled with financial fragility resulted in the crash that was the GFC. Although I found the book to be fairly technically advanced in its concepts and  formulas, I did appreciate the fundamental concepts it was based upon though.

In short, failure to consider downside risk means that the majority of the players in the market before the crash didn't give enough due consideration to what would happen in the worst case scenario (⇀‸↼‶). Tying it back to the principles of value investing, it would mean that you should always be certain of the true value of what you are buying rather than just joining in on mindless hype. As an analogy, say you bought shares of a farm, even if the paper value of the farm crashed to zero, you would still hold a (hopefully) revenue generating asset.

The second factor that was covered in the book related to financial fragility, specifically pertaining to how interconnected the components of the market are and how the failure to consider downside risk can lead to a death spiral of credit contraction, loss of liquidity and eventual crash (`ー´) .

Although I felt a little out of my depth reading this book, I found the basic gist of it easy enough to understand, and it will probably be a book that I return to when I am a bit more advanced in my studies.

By 小福