Lessons From the Brain-Damaged Investor --- Unusual Study
Explores Links Between Emotion and Results; `Neuroeconomics' on Wall Street
21 July 2005
The Wall Street Journal
D1
PEOPLE WITH certain kinds of brain damage may make better
investment decisions. That is the conclusion of a new study offering
some compelling evidence that mixing emotion with investing can lead to bad
outcomes.
By linking brain science to investment behavior, researchers concluded that
people with an impaired ability to experience emotions could actually
make better financial decisions than other people under certain
circumstances. The research is part of a fast-growing
interdisciplinary field called "neuroeconomics" that explores the role biology
plays in economic decision making, by combining insights from cognitive
neuroscience, psychology and economics. The study was published last month in
the journal Psychological Science, and was conducted by a team of researchers
from Carnegie Mellon University, the Stanford Graduate School of Business and
the University of Iowa.
The 15 brain-damaged participants that were the focus of the study had
normal IQs, and the areas of their brains responsible for logic and cognitive
reasoning were intact. But they had lesions in the region of the brain that
controls emotions, which inhibited their ability to experience basic feelings
such as fear or anxiety. The lesions were due to a range of causes, including
stroke and disease, but they impaired the participants' emotional functioning
in a similar manner.
The study suggests the participants' lack of emotional
responsiveness actually gave them an advantage when they played a simple
investment game. The emotionally impaired players were more willing to take
gambles that had high payoffs because they lacked fear. Players with undamaged
brain wiring, however, were more cautious and reactive during the game, and
wound up with less money at the end.
Some neuroscientists believe good investors may be exceptionally skilled at
suppressing emotional reactions. "It's possible that people who are
high-risk takers or good investors may have what you call a functional
psychopathy," says Antoine Bechara, an associate professor of
neurology at the University of Iowa, and a co-author of the study. "They don't
react emotionally to things. Good investors can learn to control their
emotions in certain ways to become like those people."
The study demonstrates how neuroeconomics can offer insight into a question
that has become a growing focus of economic inquiry: Why don't people always
act in their own self-interest when they make economic decisions?
Though the field is still in its infancy, researchers hope neuroeconomics
could someday have dozens of real world applications -- like explaining how
brain chemistry influences market phenomena such as bubble manias and investor
panics. Wall Street executives already are paying attention to the findings,
since it offers insight into what motivates investors.
"This branch of inquiry and economic investigation is really fortifying and
buttressing our understanding of investor behavior," says David Darst, chief
investment strategist in the Individual Investor Group at Morgan Stanley.
"It's beginning to inform our tactical decisions."
Using sophisticated brain-imaging technology such as magnetic resonance
imaging, or MRI, tests and other tools, neuroeconomists peek inside people's
brains to see which regions are activated when we engage in behaviors such as
evaluating risks and rewards, making choices and cooperating with other
people. Neuroeconomic researchers also tap into brain activity by measuring
brain chemicals and exploring how damage to specific brain regions impacts
economic decision making.
Neuroeconomics grew out of a related field called behavioral
economics. Behavioral economists use insights from psychology and other social
sciences to explore why humans don't always behave as predictably as standard
economic models suggest they should.
In the late 1990s, when the links between psychology and neurobiology were
firmly established, behavioral economists began turning to neuroscientists, in
addition to psychologists, for help explaining human behavior. The idea was
that if brain chemistry could explain phenomena such as depression or
attention deficit disorder, it might also help explain more mundane
psychological functions, such as how people reach financial decisions.
Behavioral economists, like Princeton's Daniel Kahneman, who won the Nobel
Prize for Economics in 2002, began teaming up with neuroscientists, like Peter
Shizgal at Concordia University in Montreal. In one study, the pair used
gambling games and neuroimaging techniques to look what part of the brain is
triggered when people anticipate winning money. They found that monetary
rewards trigger the same brain activity as good tastes, pleasant music or
addictive drugs.
The 41 participants in the new study included people with and without brain
damage, including a control group of participants with brain damage that
didn't affect their emotional processing. Players were given $20 and asked to
play a simple gambling game that involved 20 rounds of coin tosses. If they
won a coin toss, they earned $2.50. If they lost the toss, they had to give up
a dollar. They could choose not to play in any given round, in which case they
kept their dollar.
Logic indicates that the best strategy was to take the gamble in every
round of the game, since the return on a win was much higher than the
potential loss, and the risk in each round was 50-50. The players with
emotion-related brain damage took a more logical strategy, investing in 84% of
rounds, while the nonbrain-damaged players invested in just 58% of the rounds.
Emotionally impaired participants outperformed the nonbrain-damaged
participants, winding up with an average of $25.70 versus $22.80 at the end of
the game.
The researchers believe fear had a lot to do with the poor performance of
nonbrain-damaged participants. "If you just observe these people, they know
the right thing to do is invest in every single round," says Baba Shiv, an
associate professor of marketing at the Stanford business school and a
co-author of the study. "But when they actually get into the game, they start
reacting to the outcomes of the previous rounds."
Yet emotions may play a useful role in financial decision making.
While the brain-damaged players did well in the specific game in the study,
they didn't generally perform well when it came to making financial decisions
in the real world. Three of four of the brain-damaged players had experienced
personal bankruptcy. Their inability to experience fear led to risk-seeking
behavior, and their lack of emotional judgment sometimes led them to get
tangled up with people who took advantage of them. Their life experience
suggests emotions can play an important role in protecting our interests, even
if they sometimes interfere with rational decision making.
Humans developed this fear response as a survival mechanism to protect
against predators. But in a world where predators aren't lurking around every
corner, this fear system can be over-sensitive, reacting to dangers that don't
actually exist and pushing us toward illogical choices.
"There was no such thing as stock in the Pleistocene era," says George
Loewenstein, a professor of economics at Carnegie Mellon University, and a
co-author of the study. "But human beings are pathologically risk averse. A
lot of the mechanisms that drive our emotions aren't really that well adapted
to modern life."
---
The Price of Fear
A new study shows people with brain damage that impaired their ability to
experience emotions such as fear outperformed other people in an investment
game.
-- The brain-damaged participants were more willing to take risks that
yielded high payoffs.
-- They were less likely to react emotionally to losses.
-- They finished the game with 13% more money than other players.
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