Early one morning, you sign on to check your stock portfolio. Not surprisingly, one of your tech securities is down. You decide to sell before it goes lower. Then you buy shares in an up-and-coming company you read about in a blog. As you power down your computer to get ready for work, you reflect upon how easy, how rational, how dispassionate that was.

Not so fast. A flurry of new academic papers suggests that your trading decisions might have had their roots in sex, or in a deficiency in a certain hormone that promotes trust. Perhaps it might have been a hiccup within your prefrontal cortex. Or it might have been the aftereffect of regret you feel from a transaction last week. More simply, it might have been just plain dread of future losses.

Emotion -- not just reason -- may play a much larger role in economics than traditionally supposed, say specialists in "neuroeconomics," an emerging discipline that combines neuroscience, psychology, and economics. With recent advances in brain imaging, researchers are now able to study the brain as it makes financial decisions. While everyone acknowledges that the field is still in its infancy, there are already enough specialists to support a new Society for Neuroeconomics.

The most optimistic of the Society's members say that the discipline will yield new understandings of investor behavior. Neuroeconomics, they say, holds the prospect of biologically based investor counseling and a way to guide ordinary people to better decisions in everything from 401(k) plans to contract negotiations. Already, the new findings have given rise to a couple of firms claiming to practice something slightly scary called "neuro-marketing."

"I think we're on the cusp of a new age of understanding neurophysical response," says Andrew W. Lo, director of the Laboratory for Financial Engineering at Massachusetts Institute of Technology. "We're at a point where physics was 100 years ago. We're facing a breakthrough for neuroscience that will create a whole new set of opportunities for economists and social scientists."

While many mainstream economists still regard neuroeconomics with arched eyebrows, it may not be hyperbole to predict it as the next big thing. At the 2005 meeting of the American Economic Association, the neuroeconomic sessions were reportedly standing room only.

Perhaps those rooms were packed because of something all economists know but have mutually agreed not to mention. In the 1900s, ecnomists decided that the workings of the brain were unknowable, so they decided to ignore it, or to just consider it as a wild card in the data. The "dismal science," as it's been practiced for at least the last 100 years, is based on a convenient fallacy: that people consistently weigh the pros and cons rationally and then seek the greatest gain.

Yet even the newest Econ 1 student knows intuitively that people don't make decisions like computers. That's why economists find it so hard to explain why the Dutch bankrupted themselves speculating on tulip bulbs in the 1600s, or why, just a few years ago, investing in an online pet store seemed like the surest way to Easy Street.

Seeking to resolve these contradcitions, about 20 years ago some economists started to champion the idea that exploring the psychology of what people really do is at least as important as developing math formulas for what they should do. In 2002, Princeton University professor Daniel Kahneman won the Nobel Prize for his groundbreaking work in integrating psychological ideas into economics, creating a new subdiscipline "behavioral economics."

Neuroeconomists say they are taking behavioral economics one step further: They are seeking not only to understand the role of psychology in decision making but to pinpoint exactly what brain functions and interactions guide economic decisions.

"Things in the economy can only be deeply understood by looking at the brain. Within the economics profession, that's pretty radical," says Colin Camerer, a professor of business economics at the California Institute of Technology and president of the Society for Neuroeconomics. "There's a long tradition to accept that the processes that lead to economic decisions are not observable. We're finding that that's not true."

Economics is essentially the study of choices. Accordingly, neuroeconomists put animals and people in the position of making decisions and then scan their rains and bodies to see what the mechanics -- the neural basis -- of those choices might be.

Biologists have established that in one way the brain is like a muscle: When particular parts of the brain are in use they demand more blood. So some neuroeconomists use sophisticated brain scans like "functional magnetic resonance imaging" (fMRI) and "positron emission tomography" (PET) to trace blood flow in the brain as it happens. Others attach electrodes reminiscent of a polygraph test to track heart rate, respiration, and other data during decision making. In animal studies, hair-thin probes track decisions down to the level of a single neuron firing. Still others are investigating how the brain decides when certain areas are damaged.

In interdisciplinary papers published in psychology, economics, and neurology journals, neuroeconomists are suggesting that an economics decision is not an event, but a process, and one filled with emotion.

"The big deal here is to put economics on a biological basis," Camerer explains. "Until recently, the science that economics liked to emulate was physics. The problem with that is the particles in the system are us. And we're biological organisms."

Kevin McCabe, a professor of economics, law, and neuroscience at George Mason University, has collaborated with a team at Baylor Medical School to study the ventral and dorsal striatum, which are associated with motivation. "We're finding that people have regret processing in the brain," McCabe says. "When the market is up, people wish they had been in the market more. That strongly drives the next investment they make. That's what we think is involved in over-investment behavior."

Traditionally, economists have assumed that the reason we don't save enough for retirement is that we discount long-term rewards. But neuroeconomists are sketching a more complicated picture: A team including Harvard University professor David Laibson and Princeton's Samuel McClure scanned peoples' brains and found that completely different areas are involved in long-term versus short-term choices. If you're figuring out how much to save your 5-year-old's college education, you draw on your prefrontal cortex, the region believed to orchestrate thought and goal setting. If you're making an immediate choice, the researchers found, the more primal "limbic system" kicks in: "I want ice cream now!"

Our monetary decisions may be even more primordial: A 2005 study in the journal Neuron found that monetary rewards affect the brain much like cocaine or amphetamines. Brian Knutson, a professor of psychology and neuroscience at Stanford University, and fellow researchers have found that when our brains are in a "positive arousal state" -- after a triumph, say -- we're more likely to take foolish risks. Yet when we think about costs, we play it safe, probably too safe, at least in the lab, Knutson found.

Paul J. Zak, director of the Center for Neuroeconomics Studies at the Claremont Graduate University in California, has linked the hormone oxytocin to the level of trust in financial transactions. Zak says his research suggests that strong economies depend on the levels of happiness, trust, and oxytocin in a country's populace.

"No question, we're going to find ways in which the emotional system doesn't help us economically," says McCabe, of George Mason University. "But the answer isn't to get rid of emotions. Rather it is to use them effectively."

In a 2002 study, Lo of MIT wired up securities traders to an array of electrodes. As the traders bought and sold, Lo measured their skin conductance, heart rate, breathing rate, and blood pressure. He concluded that anxiety and fear played a large, and sometimes positive, role in financial decision making.

"We're finding out that even the most experienced traders have an emotional aspect to their decision process," Lo says. "It's not true that the traders with the least emotional response make the best decisions. There's an important link between good financial decisions and proper emotional responses. Traders are not the number crunchers that academics make them out to be."

Lo is now trying to develop a mathematical model for "adaptive markets" that takes this kind of emotional input into account.

So where might all this theoretical research lead? It's already given rise to a few neuromarketing firms, such as BrightHouse in Atlanta and NeuroSense Limited in London, says Zack Lynch, managing director of NeuroInsights, another neurotechnology consulting firm in San Francisco.

Scientists in places as far-flung as Nihon University in Japan are scanning people's brains as they look at a variety of products -- everything from Coke versus Pepsi to cars. Already there are consultants, like Market Psychology Consulting in San Francisco, that use behavioral finance ideas to help investors make better decisions.

According to Lynch, one thing though, is for certain: "The future will be about understanding and leveraging emotions."

(source: Spirit Magazine, September, 2006) http://www.spiritmag.com