By
Mark R Stephens
One area where the growth of
neuroscience has been particularly notable in recent years is economics.
It may, at first, seem a strange
relationship, but neuroscience has allowed us to better understand how the
brain works and how decisions are made. This is key to understanding investment
decisions, so, when viewed in this light, it is a perfectly natural connection
to make.
Studies on risk: the investing brain
A recent U.S. study looked at the
effect of different levels of monetary risk on the human brain. 61 participants
were asked a variety of questions such as "Would you prefer a 50 percent
chance of receiving $5 or would you rather take a 13 percent chance of winning
$50?" and "Would you prefer $10 for sure or a 50 percent chance of receiving
$50?"
It was found that the make up of the
gray matter of participants' brains contributed to the levels of tolerance to
risk; the more gray matter in the right posterior parietal region of the
cortex, the riskier the responses.
While this study has some
interesting findings, it is limited and its major importance is in
demonstrating the types of relationships that are currently being investigated
through neuroscience. This is a taste of things to come, as scanning methods
become even more advanced and more specialists are able to interpret the data.
This coming together of economics,
neuroscience and psychology has given rise to 'neuroeconomics', which has
advanced the understanding of economic decision-making.
In the past, economic models have
been designed with little understanding of how the human brain works. Predictive
models were designed by economists who understood the mathematics very well,
but the models would repeatedly fail due to a lack of allowance for human
behaviour.
Understanding more about how the
brain influences decision-making and thus behaviour is therefore a major
breakthrough as economists can include more realistic models of choice.
The choosing brain
Studies have helped to demonstrate
that people generally become more risk-averse as they age; and this would seem
to correspond with a thinning of the brain's cortex in older age.
This has consequences for important financial
decisions that aging people need to make like choosing the most suitable
retirement or health plan; even the most intelligent older adults can make
errors and can lose money through very simple mistakes in the selection
process.
Traditional models can now
accommodate more of what we know about the decision-making of aging brains, for
instance, by providing clearer options and simplifying the process of making
financial choices. By presenting options in such a way that it plays to the
strengths, not weaknesses of the brain, makes it less likely that expensive
errors will be made amongst the elderly. It also reduces the need for a 'trial
and error' type of approach, making policy design better.
The trading brain
Another area of economics that has
come under the microscope from neuroscience is trading. The interest in what is
going on in the brain when traders make their decisions to buy or sell is not
surprising, given the huge stakes.
A U.S. study earlier this year
looked at trading success and how it was associated with areas of the brain
associated with reward and response to gut feelings.
One of the findings from the study
was that an area called the 'nucleus accumbens' (associated with reward) was
more active and excited when prices rose; the second key finding was that the
more successful traders received signals from the 'anterior insular cortex',
which is an area that is active during bodily discomfort and unpleasant
emotional states: like an in-built warning to sell before a bubble bursts.
Brian Knutson, a neuroscientist at Stanford
University, interpreted the findings like this:
"This research shows that neural
signals not only correspond to but predict important financial events in an
experimental market."
Perhaps this is how the likes of
Warren Buffett do so well, while others fail? Does he receive brain signals and
gut warnings when to buy and sell? It's an intriguing thought and one of the
many questions that neuroscience throws up in the field of economics.
