Researchers have looked into investment biases such as home bias or habit formation for a long time — but often without directly linking these insights to the stability of the financial system. The behavioural finance literature shows that departing from the assumption of full rationality can help explain many real world phenomena.
Distorted beliefs, excessive trading, insufficient diversification, or other examples of suboptimal investment behaviour can be attributed to psychological biases (Barberis and Thaler 2003). Implications of behavioural models for the financial system depend on the ability of informed, rational traders to offset the induced distortions. Recent literature has made advances by linking decision making at the individual level to macroeconomic outcomes.