Thursday, April 2, 2015
FAIRFIELD-SUISUN, CALIFORNIA
99 CENTS

When brain says buy, you may not know why

By
From page B7 | July 13, 2014 |

Billions of neurons fire in the brains of stock market traders as they decide whether to buy or sell shares in a matter of seconds. Some of these brain waves produce rational calculations about how best to make a profit, but others may not, suggests new research from the nascent field of neuroeconomics — a discipline that takes a physiological approach to understanding economic decision-making.

The new study shows that activity in a part of the brain associated with pleasure and reward flares to life during trading. The researchers say this may cause traders to buy too aggressively and ultimately drive stock market bubbles to inflate and burst.

Speculative bubbles have plagued economies for centuries; they occur any time prices soar far above the fundamental value of an asset. In the early 1600s, the Dutch pawned their heirlooms and sold their farms to buy contracts for tulip bulbs during an episode remembered as Tulip Mania. Many more followed, including the dot-com craze of the late 1990s and the U.S. housing bubble fueled by flimsy mortgage-backed securities that plunged the world into the worst recession since the Depression.

But economists and neurologists have long debated how and why speculative bubbles get started in the first place. At the root of the disagreement is the question of whether investors act rationally or irrationally during bubbles, and thus whether they constitute an inherent feature of financial markets.

As far back as 1988, researchers have found that bubbles emerge even in laboratory settings, when people trade in experimental markets without any uncertainty. One idea is that people simply get overly excited about rising prices – a phenomenon former Federal Reserve Chairman Alan Greenspan called “irrational exuberance.”

“For whatever reason, if you put a bunch of people together and they start trading, these markets generate bubbles,” said Alec Smith, a neuroeconomist at the California Institute of Technology in Pasadena and lead author of the new study published Monday in the Proceedings of the National Academy of Sciences.

That’s exactly what Smith, who spent seven years working as a professional stock trader, found in his latest experiment. He and his colleagues set up more than a dozen experimental markets that included about 20 college-age participants who traded for 50 rounds. (While college students are not professional traders, previous studies have found no difference in their behavior, Smith said.)

Each player started with 100 units of risk-free currency and six units of a hypothetical risky asset. There wasn’t much uncertainty in the market: Traders knew the interest rate of the currency, the expected dividends on the risky asset and its fundamental value.

In each market, two or three of the traders conducted their business from the inside of an MRI machine while the researchers watched their brains in action. By tracking the flow of blood to active areas of the brain in need of oxygen, the researchers found that a part of the brain called the nucleus accumbens lighted up during trading.

Set deep behind the eyes, the nucleus accumbens plays a central role in the brain’s reward circuit and helps regulate both motivation and addiction. It floods with dopamine when we get what we want, and it flares during arousal and drug use.

During the experiment, Smith and his colleagues found that activity in this powerful and not particularly rational part of the brain closely tracked rising stock prices. The more nucleus accumbens activity the scientists registered in the traders’ brains, the higher the prices rose.

Neural activity even predicted the imminence of a crash – when blood flow soared, prices reached perilous highs before tumbling back to the asset’s fundamental value.

However, not all traders showed the same brain patterns. One astute group – people who tended to sell earlier than the rest and thus earned the most during the experiments – showed activity in another part of the brain as the bubbles grew.

The anterior insula usually alerts people to physical discomfort, like a racing heartbeat or a feeling of fullness. But it has also been shown to respond to risk. In the small group of high-earning traders, the anterior insula sounded alarm bells that caused them to shed their risky assets before others.

But for most traders, the hedonistic nucleus accumbens dominated the cautious anterior insula, creating stock market bubbles.

“The cumulative evidence from these papers and others is that emotions matter for financial behavior, and can in fact drive stock prices,” said Camelia Kuhnen, an economist at the University of North Carolina, Chapel Hill who was not involved in the study.

The study does not prove that irrational behavior rules the markets, Smith acknowledged. Activity in the nucleus accumbens could coincidentally track trading for other reasons, although the brain region’s involvement in addiction, overeating and gambling make that unlikely, he said.

If anything, the study suggests successful traders should lean on their emotional misgivings a little more. Smith takes this as empirical evidence for this famous maxim from investor extraordinaire Warren Buffett: “Be fearful when others are greedy, and greedy when others are fearful.”

Los Angeles Times

LEAVE A COMMENT

Discussion | No comments

The Daily Republic does not necessarily condone the comments here, nor does it review every post. Read our full policy

  • Recent Articles

  • Enter your email address to subscribe and receive notifications of new posts by email.

  • .

    Solano News

    Special police unit undergoes mutual aid training in Vacaville

    By Kevin W. Green | From Page: A1 | Gallery

     
    College faculty shows solidarity as contract talks continue

    By Susan Winlow | From Page: A1 | Gallery

     
    Pursuit of happiness may need makeover

    By Mayrene Bates | From Page: A2

     
     
    Pickleball decision stalls in Vacaville

    By Ryan McCarthy | From Page: A3 | Gallery

    Energy saver workshop to take place in Suisun

    By Ian Thompson | From Page: A3

     
    Authorities cite speed in rollover crash

    By Kevin W. Green | From Page: A4

    Il Fiorello schedules April cooking classes

    By Susan Hiland | From Page: A4

     
    Lynch Canyon site of 7th annual Kite Festival

    By Susan Hiland | From Page: A4

     
    Chabad of Solano County to host Passover Seders

    By Amy Maginnis-Honey | From Page: A4

     
    Fairfield police log: March 31, 2015

    By Susan Hiland | From Page: A10

    Fairfield police log: March 30, 2015

    By Susan Hiland | From Page: A10

     
    Suisun City police log: March 31, 2015

    By Susan Hiland | From Page: A10

    Suisun City police Log: March 30, 2015

    By Susan Hiland | From Page: A10

     
    .

    US / World

    Snowpack dismal as governor orders cuts

    By The Associated Press | From Page: A1

     
    Wrongful death trial slated in teen suicide case

    By The Associated Press | From Page: A4

    Trespassing woman believed to have jumped fence

    By The Associated Press | From Page: A4

     
    Man’s death linked to too much iced tea

    By The Associated Press | From Page: A5

    Arkansas governor backs away from bill called ‘anti-gay’

    By The Associated Press | From Page: A5

     
    Districts seeking waiver from NCLB mandates

    By The Associated Press | From Page: A5

    National park admission fees set for an increase

    By The Associated Press | From Page: A5

     
    Iraq hails victory over Islamic State extremists in Tikrit

    By The Associated Press | From Page: A6

    Double overtime: Faltering Iran nuclear talks extended again

    By The Associated Press | From Page: A6

     
    Alps crash: Bodies recovered, but families must wait months

    By The Associated Press | From Page: A6 | Gallery

    .

    Opinion

     
    Aquino wants to make Philippines into Detroit

    By William Pesek | From Page: A7

    What’s driving you to distraction?

    By Kelvin Wade | From Page: A7

     
    Maybe need more for airplane security

    By Letter to the Editor | From Page: A7

    Thank you for your help

    By Letter to the Editor | From Page: A7

     
    Clinton: Our 1st woman president

    By Letter to the Editor | From Page: A7

    Editorial Cartoon: April 2, 2015

    By Daily Republic Syndicated Content | From Page: A7

     
    .

    Living

    Today in History: April 2, 2015

    By The Associated Press | From Page: A2

     
    Community Calendar: April 2, 2015

    By Susan Hiland | From Page: A2

    Horoscopes: April 2, 2015

    By Holiday Mathis | From Page: A9

     
    2nd-place wife needs to decide if she’s better off without husband

    By Kathy Mitchell and Marcy Sugar | From Page: A9

    .

    Entertainment

    Cynthia Lennon, first wife of John Lennon, dies of cancer

    By The Associated Press | From Page: B4 | Gallery

     
    TVGrid

    By Daily Republic Syndicated Content | From Page: B4

    Dish’s Internet TV, Sling, gets HBO service for $15 a month

    By The Associated Press | From Page: B4

     
    Mark Wahlberg to produce Boston Marathon bombing movie

    By The Associated Press | From Page: B4

    .

    Sports

    Chavez allows 3 hits in 6 innings as A’s beat Angels 4-1

    By The Associated Press | From Page: B1

     
    Harden’s career-high 51 lead Rockets over Kings 115-111

    By The Associated Press | From Page: B1

     
    Miami, Stanford meet in NIT final matchup of banged-up teams

    By The Associated Press | From Page: B1

    Bumgarner outpitches Kluber as Giants beat Indians 5-2

    By The Associated Press | From Page: B1

     
    AP Source: Kings to sign 1st NBA player of Indian descent

    By The Associated Press | From Page: B2

    Mullin: Trying to turn around St John’s an ‘obligation’

    By The Associated Press | From Page: B2

     
    California development for sports stadiums moves forward

    By The Associated Press | From Page: B2

    St. Louis County pulls taxpayers from NFL stadium financing

    By The Associated Press | From Page: B2

     
    Letters from old Yankee Stadium fail to sell at NYC auction

    By The Associated Press | From Page: B2

    Serena Williams earns 700th win to reach Miami Open semis

    By The Associated Press | From Page: B2

     
    US Senators want FIFA to move 2018 World Cup out of Russia

    By The Associated Press | From Page: B2

    NIT, MSG agree to 3-year contract extension through 2018

    By The Associated Press | From Page: B2

     
    Jordan Spieth, Patrick Reid ready for Houston Open

    By The Associated Press | From Page: B2

    IndyCar’s new aero kits leave debris trail in season opener

    By The Associated Press | From Page: B2

     
    Will Indiana law force 2016 women’s Final Four to relocate?

    By The Associated Press | From Page: B2

    .

    Business

    .

    Obituaries

    William Dean

    By Nancy Green | From Page: A4, 1 Comment

     
    Acencion “Ghenido” Zepeda

    By Susan Hiland | From Page: A4

    Manuel D. Ramos Sr.

    By Susan Hiland | From Page: A4

     
    Charles Bell

    By Nancy Green | From Page: A4

    .

    Comics

    Blondie

    By Daily Republic Syndicated Content | From Page: A8

     
    Baby Blues

    By Daily Republic Syndicated Content | From Page: A8

    B.C.

    By Daily Republic Syndicated Content | From Page: A8

     
    Get Fuzzy

    By Daily Republic Syndicated Content | From Page: A8

    Wizard of Id

    By Daily Republic Syndicated Content | From Page: A8

     
    Zits

    By Daily Republic Syndicated Content | From Page: A8

    Frank and Ernest

    By Daily Republic Syndicated Content | From Page: A8

     
    Baldo

    By Daily Republic Syndicated Content | From Page: A8

    Rose is Rose

    By Daily Republic Syndicated Content | From Page: A8

     
    Pickles

    By Daily Republic Syndicated Content | From Page: A8

    Peanuts

    By Daily Republic Syndicated Content | From Page: A8

     
    Beetle Bailey

    By Daily Republic Syndicated Content | From Page: A8

    Dilbert

    By Daily Republic Syndicated Content | From Page: A8

     
    Sally Forth

    By Daily Republic Syndicated Content | From Page: A8

    Bridge

    By Daily Republic Syndicated Content | From Page: A9

     
    Sudoku

    By Daily Republic Syndicated Content | From Page: A9

    Cryptoquote

    By Daily Republic Syndicated Content | From Page: A9

     
    Crossword

    By Daily Republic Syndicated Content | From Page: A9

    Word Sleuth

    By Daily Republic Syndicated Content | From Page: A9