Home Companies Industry Politics Money Opinion LoungeMultimedia Science Education Sports TechnologyConsumerSpecialsMint on Sunday

Kellogg School Corner: Brain circuits and trade risks

Kellogg School Corner: Brain circuits and trade risks
Comment E-mail Print Share
First Published: Mon, Jul 30 2007. 12 06 AM IST
Updated: Mon, Jul 30 2007. 12 06 AM IST
Most finance scholars have surely spent little time thinking about “distinct neural circuits linked to anticipatory affect” or why “the nucleus accumbens (NAcc) of the ventral striatum shows proportional activation during anticipation of monetary gains”.
But the Kellogg School of Management’s Donald P. Jacobs Scholar in Finance Camelia Kuhnen is not “most scholars”. A senior lecturer at the Kellogg School, Kuhnen is a pioneer in neurofinance, an emerging field that explores the intersection of neuroscience and economic theory. The Neural Basis of Financial Risk Taking, the study she completed with research partner Brian Knutson at Stanford, appeared in the September 2005 issue of Neuron magazine.
When asked to describe her research in terms a layperson could understand, Kuhnen begins with a brief lesson in neurology. She opens a laptop and pulls up an MRI image of a brain, a thin slice of data taken from deep within. The prefrontal cortex—the region of the brain associated with reason, long-term planning and cognition—is nowhere to be seen. The slice on display here is older, simpler, closer to the spinal column. Two small areas near the centre are aglow with activity.
Kuhnen points to the image on the laptop screen. This is a view of the limbic system, she says, the primitive, emotional part of the brain. Because economic theories tend to hinge on the presumed rationality of relevant actors, she notes, economists have not traditionally had much use for the limbic system. She indicates the two bright spots among the grey matter. One is the NAcc, which motivates people to seek reward. It lights up when a hungry person sees a fruit tree or a chocolate cake in the distance and seems to encourage quick action to procure the food. If a hungry man is sprinting toward an apple orchard, says Kuhnen, his NAcc is almost certainly charged with purpose.
The other active area on screen is the anterior insula—the limbic system’s wary answer to the NAcc. The anterior insula is concerned not with seeking reward, but with avoiding risk. If a snake slithers up to the hungry man in the apple orchard, activity spikes in the anterior insula, prompting him to run for his life.
Both areas “deal with gut feelings” of one sort or another, says Kuhnen.
So what could these primitive impulses possibly have to do with high-level cognitive processes such as picking a winner on Wall Street or managing a blue-chip portfolio? According to Kuhnen, there is no escaping the fundamental risk/reward functions of the limbic system. “It kicks in even if the situation is not about running for food or running away from snakes,” she says.
Kuhnen returns to the study featured in The Neural Basis of Financial Risk Taking. Participants were asked to perform a simulated investment task while under observation in an MRI machine. The experiment offered subjects choices between “good” stocks and “bad” stocks (the “bad” being more likely to yield negative returns and less likely to yield positive ones than the “good”) while equipment monitored and recorded activity in the NAcc and the anterior insula.
Though people rely on both areas to help them decide quickly what to risk in pursuit of rewards, the gut (i.e. the jumpy limbic system) is not always the most helpful tool to the modern-day savvy investor. “The more activation you have in these two areas, the more likely you are to make a mistake,” says Kuhnen. The mistakes Kuhnen’s and Knutson’s investors made fell into two neat categories, each perfectly avoidable to the rational actor. Subjects who were too risk-averse were shown consistently to be impaired by an overactive anterior insula at the time they made the poor choices, and subjects who mistakenly took too many risks were operating under the influence of excess NAcc activity.
Given the consistency of these results, Kuhnen theorized that she and Knutson would be able to predict not only when a subject was about to make a mistake, but also what sort of mistake (risk-seeking or risk-averse) it would be. To test their hypothesis, they began to measure activity in each area two seconds before each choice was made. It turned out, says Kuhnen, that the experimenters could indeed make meaningful predictions about these behaviours.
While the body of neurofinance research is small, its implications could be large for economists and individual investors. “Once you have this model, you know what’s inside the ‘black box’,” Kuhnen says. If investors can understand their most basic, least rational motives, they can begin to find ways to compensate, or attenuate, bad choices. For the prudent investor, Kuhnen says even something as simple as acknowledging that “it’s sunny outside and you’re happy” (and therefore more likely to feel biologically driven to a gamble) might help prevent a risky mistake on the trading floor.
She adds that pending further research, academics in finance and related fields may find themselves adding a whole new dimension—the possibility that investing is more than a game of numbers, whether or not investors know it—to their research: “If we write theory models of choice, we should be motivated to include affect and emotions (as variables).”
Kuhnen’s research on neurology and financial decision making continues. With co-authors from Stanford University and the University of Washington, she is exploring the effects of ageing on financial choices. Since many studies have shown that ageing affects the brain, says Kuhnen, it will be valuable to know whether age-related physiological changes also influence financial choices.
Kuhnen says more research is necessary. “I cannot tell you a trading strategy based on this (set of findings),” she says, but the MBA student or investor would do well to “be aware that affect plays a role” in financial decisions to avoid dismissing the subtly powerful force of the primitive brain.
Aubrey Henretty is a staff writer at the Kellogg School of Management. This article is based on the research of Camelia Kuhnen, assistant professor of finance at the Kellogg School of Management, and Brian Knutson,assistant professor of psychology and neuroscience at Stanford University.
Send your comments to kelloggscorner@livemint.com
Comment E-mail Print Share
First Published: Mon, Jul 30 2007. 12 06 AM IST
More Topics: finance | trade | Marketing and Media | Campaign |