What happens to the brain when choosing between two financial products? What happens when the decision is considered “at risk”? Can personal decision making predict how financial markets operate?
These are the problems that arise from the relationship between neuroscience and finance…sometimes called “neuro finance” or “neuroeconomics.”
Understanding what happens in the brain when we make financial decisions is a relatively new science, but it has proven to be interesting.
A new laboratory at the University of Miami Business School has been set up to study the relationship between the brain and finance.
Using electroencephalography (EEG) to measure electrical activity in the brain, as well as eye tracking technology, it allows experiments with financial students without the need for expensive fMRI techniques.
One of the main researchers explained what neuroscience is trying to discover:
“Money does not exist in essence. When a person says, ‘I will save 20% of my salary to deposit into a retirement account’, is ‘the same part of the brain that the squirrel used to give up the nuts for the winter?”
“We are trying to figure out what part of the brain we use to make financial decisions today, what they were going to do, and their consistency.”
The common assumption is that the decisions we make (about finance or other things that are considered “important”) are purely rational decisions without emotional interference. On the financial side, a large number of metrics are used to enable us to make “smart” decisions.
However, laboratory findings support previous neuroscience, suggesting that emotion plays a very important role in all decisions.
The work of neuroscientist Antonio Damasio proves that people who are hurt in the brain can’t make decisions – even simple people like what to wear.
In one of the experiments, students were given two institutions with identical indicators, but different people managed the funds. The latter information should not be a factor in analyzing which fund, but students always choose an American name instead of a foreign name. This is the impact of emotions in the decision-making process.
Can this help explain financial markets?
Neuroeconomics is an evolving field that includes many fields, including neuroscience, experimental and behavioral economics, cognitive and social psychology, theoretical biology, and mathematics.
One of the most important issues in the field is to understand whether what’s happening in your brain can extend to financial market behavior when making financial decisions.
The Principal Investigator of the University of Miami Business School recommends the following:
“If you really think about the market, that’s a series of people doing things. If you really want to understand group behavior, then it makes sense to understand how they make decisions at the individual level.”
A study by the California Institute of Technology clarified this point more, suggesting that predicting other people’s behavior is a biological impulse – which helps drive the type of “prosperity” and “depression” market volatility. It turns out that traders do not make calm decisions based on clear price and value data, but rather predict how the market will change from the behavior of other traders (believing other people in the market know better than them).
Next time you are about to make a financial decision, stop and think about it: What are the factors driving this decision? Is it really just analysis and numbers? Still excited in the background?