The ups and downs of the stock market reflect investors' balance between greed and fear, goes an old saying. Until now, though, economists have not had a way to incorporate such emotions into their models of investors' strategies. However, in the September 1, 2005, issue of Neuron, Camelia M. Kuhnen and Brian Knutson of Stanford University report the identification of two key brain regions activated before people make risk-seeking versus risk-aversion investment mistakes.
They said that their findings may help to "ultimately improve the design of economic institutions so as to facilitate optimal investor behavior." They also said they believe their experimental design--which they call the "Behavioral Investment Allocation Strategy"--enables researchers to bring the real-life equivalent of individual investment behavior into the laboratory.
In their experiments, the researchers asked volunteers to make investment decisions among two stocks and a bond by pressing buttons. Before each trial run, the researchers "showed them the money," telling the subjects that they would receive a percentage of the cash that they made by investing or would lose cash from their participation fee if they were not successful. Without telling the subjects, the researchers randomly designated one of the stocks a "bad" stock more likely to lose money or as a "good" stock that was more likely to make money. The bond was a safe but conservative investment.
The researchers then scanned the subjects' brains using functional magnetic resonance imaging (fMRI) as they proceeded through a series of decisions on investing in the pairs of the stocks or with the bond and learned the outcomes of those decisions. The commonly used technique of fMRI utilizes harmless magnetic fields and radio signals to map detailed blood flow in brain regions, which reflects activity.
The researchers' analyses of the subjects' choices and brain activity revealed that an area called the nucleus accumbens (NAcc) tended to distinctively activate before the researchers made investing mistakes that were "risk seeking." That is, they decided to invest in a stock whose history had shown it to be "bad."
Conversely, found the researchers, the brain area called the anterior insula activated before the subjects made "risk-averse" mistakes--for example, investing in the bond when they had an opportunity to invest in a "good" stock.
The researchers wrote that their results "indicate that, above and beyond contributing to rational choice, anticipatory neural activation may also promote irrational choice. Thus, financial decision making may require a delicate balance--recruitment of distinct circuits may be necessary for taking or avoiding risks, but excessive activation of one mechanism or the other may lead to mistakes."
Kuhnen and Knutson concluded that "Overall, these findings suggest that risk-seeking choices (such as gambling at a casino) and risk-averse choices (such as buying insurance) may be driven by two distinct neural circuits involving the NAcc and the anterior insula. The findings are consistent with the notion that activation in the NAcc and anterior insula, respectively, index positive and negative anticipatory affective states and that activating one of these two regions can lead to a shift in risk preferences. This may explain why casinos surround their guests with reward cues (e.g., inexpensive food, free liquor, surprise gifts, potential jackpot prizes)--anticipation of rewards activates the NAcc, which may lead to an increase in the likelihood of individuals switching from risk-averse to risk-seeking behavior. A similar story in reverse may apply to the marketing strategies employed by insurance companies," they wrote.
(source: EurekAlert, August 31, 2005; http://www.eurekalert.org)