Perrow's book Normal accidents (1984) summarizes that technology intensive industries are more prone to suffer those accidents, due to:

- Complexity (nonlinearities.

- Tight coupling (multiple stages of a process which depend intimately on prior stages executing correctly.

1xtra*: absence of negative feedback over an extended period of time.

It is hard-wired in human behavior that we underestimate risk if nothing has happened recently.

e.g.: nuclear power plants, chemical industries, space programs, ..
Since 1974, 18 national level Banking Crisis around the world ('77 Spain, '87 Norway, '91 Finland and Sweden, '92 Japan.

Rogoff & Reinhart find these among the causes of the current crisis:
- Rising housing and stock markets
- Capital inflowsLarge public debt/GDP
- Financial liberalization

Measures aiming Crisis Preparation and Crisis Prevention (gathered from specialists):

- Break up banks and broker/dealers that are too big to fail

- Create exchanges for CDSs and other large OTC contracts

Create financial N1SB for analyzing all blow ups

Require confidential disclosure regarding "network"exposures

- Implement counter-cyclical leverage constraints for bank-like entities

- Enforce "suitability"requirements for mortgage-broker advice

- Require certification for mgmt. and boards of complex financial institutions

Impose more mark to market accounting and risk controls

Impose capital adequacy requirements for all bank like entities

Create new discipline of risk accounting

Impose small derivatives tax to fund financial engineering programs

Revise laws to allow "pre-packaged"bankruptcies for finance companies

Change corporate governance structure (compensation, CRO role, etc.)

- Teach economics, finance and risk management in high school

About Behavioral Finance

Behavioral Vulnerabilities:

About Prospect Theory: An Analysis of Decision under Risk

The theory distinguishes two phases in the choice process: an early phase of editing and a subsequent phase of evaluation; the editing phase consists of a preliminary analysis of the offered prospects, which often yields a simpler representation of theses prospects, whereas the edited prospects are evaluated in the second phase and the prospect of the highest value is chosen.

Outcomes which are obtained with certainty are overweighted relative to uncertain outcomes. Certainty increases the aversiveness of losses as well as the desirability of gains

In the positive domain, the certainty effect contributes to a risk averse preference for a sure gain over a larger gain that is merely probable; in the negative domain, the same effect leads to a risk seeking preference for a loss that is merely probable over a smaller loss that is certain (the overweighting of certainty favors risk aversion in the domain of gains and risk seeking in the domain of losses)

Value function: Reference point + Magnitude of the change. (vs final welfare states)

The value function is normally concave above the reference point and often convex below it, meaning, the marginal value of both gains and losses generally decreases with their magnitude.

Losses loom larger than gains; the aggravation that one experiences in losing a sum of money appears to be greater than the pleasure associated with gaining the same amount (i.e.: the value function for losses is steeper than the value function for gains).

Because people are limited in their ability to comprehend and evaluate extreme probabilities, highly unlikely events are either ignored or overweighted, and the difference between high probability and certainty is either neglected or exaggerated.

... which leads to perceive both insurance and lottery/gambling as atractive.

It is suggested that a person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise (e.g.: Leeson at Barings Bank, Citron at Orange County)