Risky Choices

The human nervous system is an amazingly interconnected structure, with one small part being able to influence & regulate many cells of the body. The three major components that act in this so called “space-time extended” manner are the secretory hypothalamus, the autonomic nervous system ANS, and the diffuse modulatory system. Together, they shape our behavior in a manner that we might not even be able to actively influence.

Additionally, signals arriving in the central nervous system CNS are rarely just processed in the area of arrival but are relayed to, influenced by, and sometimes even suppressed by other areas. After all, we are not just simple “input-output” machines that operate according to strict (or as Finance usually calls it, rational) rules.

Related to this, there has been a lot of research recently on how humans evaluate & process financial risk. Can it really be broken down to, as traditional Finance tries to theoretically predict, a purely rational process or is there more goind on behind the curtains? Turns out, there is.

Two conceptually similar models on financial risk processing have been proposed in the past years, and both set an end to rationality: Risk processing is, at its core, a largely emotional process.

Above-mentioned models are the Anticipatory Affect Model (by Wu, Sacchet & Knutson, 2012) and the Risk Processing Model (by Mohr, Biele & Heekeren, 2010). In essence, both models suggest that a risky input is processed in different parts of the brain (depending on the magnitude of risk), and especially in parts that are responsible for emotional processes. Only in a later step, then, is a cognitive decision made; however, this decision is largely influenced by the underlying emotional evaluation (or affect) of a risky alternative.

Another study (Jung et al., 2018) has even found differences in structural and functional connections between the amygdala and the prefrontal cortex among individuals with varying risk preference. Risk averse individuals even seem to display similar amygdala – prefrontal cortex connectivity as individuals showing traits of anxiety.

These examples are yet again a great illustration of the highly complex processes going on in our brain when doing a presumably simple – or supposedly rational – task. Additionally, they prove that Finance (and really all fields of study dealing with humans) should not be oblivious to the findings and discoveries of neuroscientifical research.

Addicted

A couple of weeks back in this blog we touched upon some interesting research relating to dopamine receptor activation, and the way in which this can influence the impulsiveness of our decisions.

Our attention in chapter 6 of the book was caught by Solomon H. Snyder’s account on how he and his colleagues successfully identified opiate receptors for the first time in the 1970s. During this period of time “hundreds of thousands of American soldiers” fighting in the Vietnam war were addicted to heroine, to such an extent that it was called an epidemic. One study estimated that during the war, 43% of the around 14 thousand men who returned from Vietnam had used some narcotics during their time in battle (Robbins et al., 1974). Even though the terrors of war are in practice unimaginable to us, it’s easy to understand at least a simple logic of why soldiers would resort to drugs in the midst of such chaos.

Why is it, however, that in everyday life people get addicted to drugs?

If one would really want to explore this question, there would surely be hundreds of points of views to take, even if only looking for academic explanations and answers. Sociological or economic rationales, for instance, have to our knowledge provided important insight for policy-making regarding drug addiction and abuse.

However, if looking at this question from the point of view of cellular-level action in the brain, earlier neuroscience research seems to have pointed at least a answer again to the same brain’s dopamine system and its provision of a feeling of instant gratification to the user. Drugs such as cocaine and methamphetamine cause nerve cells to release too much of the dopamine neurotransmitter, which can make one feel “euphoric”. In addition, your brain learns to release dopamine also not only due to the drugs but due to other cues that relate to the drug use, therefore disturbing your “reward circuit”.

From a behavioural economics or science point of view, such decision to pursue immediate satisfaction was also discussed during a lecture. Our lecturer talked about preferring chocolate – which in some research has also been proven to release dopamine, and at least influence other neurotransmitters – immediately in the moment or, for example, in two hours’ time. The economics research explained people’s inability to wait for gratification even for a couple of hours, by our time preferences for “consumption”. Given the same good now or in the near future, studies show we mostly prefer taking the product right away, and this can be modeled mathematically by discounting the utility received from a good into the future. Additionally, our lecturer pointed out that often humans are also incapable of making consistent choices over time.

Increasingly, however, there seems to be a view among neuroscientists that the effect of drugs is not only limited to their influence on the dopamine system, but also to cognitive patters stored in the frontal lobe. These include decision-making abilities, planning and memory. Therefore, there are surely even more areas of overlap for neuroscience and behavioural economics, when focusing on drug abuse and addiction.

Tasty Memories

This week’s topics revolved all around our different senses: Smelling, tasting, seeing, and how these inputs are being processed by our brain. Admittedly, making a sensible link between these topics and behavioral finance – besides the obvious connection of seeing what is happening around us, making sense of it, and reacting to it accordingly – makes writing this blog post a more difficult task. We found, however, some interesting parallels between our two subjects of interest.

Mmmmh, Pizza…

First stands the remarkable fact that smell and taste (which together form our perception of flavor) don’t pass through our brain as simple ad-hoc perceptions: the mouth-watering sensation of eating a pizza, or the sudden alarming sensation of your pizza getting burnt in the oven.

On the contrary, flavor perception is intrinsically linked with certain types of memory formation. To prove our point, simply go back two sentences and observe your reaction to reading about pizza. Most likely you WILL instantly get that mouth-watering feeling as if you are about to take a bite! Similarly, evoking some of our strongest memories are oftentimes tied to perceptions of smell and/or taste. The distinct smell of the house you grew up in, the perfume a loved one uses, etc.

All of this raises the question: How large is the potential effect flavor sensations can have on our behavior?

Scent Marketing

Even though you might never have heard of this term, you will most likely have “fallen for it” many times already. Scent Marketing is the deliberate and strategic use of scents to influence consumer behavior, affect brand perception, and ideally, increase buying tendency. (https://medium.com/@vishalnoel7/a-type-of-marketing-which-you-probably-didnt-know-of-scent-marketing-5db27578014c)

If the scent dispersed in or by a clothing store, coffee shop, or bakery can have such a large impact on you, what could be the potential applications of this in Behavioral Finance? Could panic sales on Wall Street be mitigated by diffusing the soothing scent of lavender on the trading floor? 😉

A Tale of Two Tables

Coming back to visual perception, another very interesting concept that was covered in the Finance and Neuroscience courses is the “Table Illusion”.

When looking at the two tables below, which of the two would you say is longer, and which is wider?

Shepard’s Table Illusion (Source: https://en.wikipedia.org/wiki/Shepard_tables#/media/File:Table_shepard.preview.jpg)

In fact, both have exactly the same dimensions! The interpretations of this illusion in Neuroscience and Behavioral Finance differ, however. Without going into too much detail in both:

  • Neuroscience: We perceive the two tables as having different dimensions because our brain is trying to use a 3D interpretation of a 2D illustration, leading to “errors” in size perception.
  • Behavioral Finance: Your intuitively & automatically thinking System 1 prematurely jumps to the conclusion that the tables’ dimensions are unequal. At the same time, we fail to scrutinize System 1’s suggestion and consider it to be true, because our deliberate & actively thinking System 2 (which would be responsible for this task), is lazy. In short, we fail to question our own initial conclusions.

These two explanations do not seem to have the same scope at first sight and tackle the problem from different angles. For us, however this is exactly what motivates us to not only look at Finance questions from a behavioral perspective, but also consider the possible neural origins behind it.

For more reading on the above-mentioned System 1 and System 2, we can highly recommend behavioral scientist & nobel-prize winner Daniel Kahneman’s book “Thinking, fast and slow”.

Disclosure: The authors’ don’t earn a commission on pizzas or books mentioned in this article being sold.

Dope-amine decisions

In recent lectures for a course in the Business School called Behavioural and Sustainable Finance, the hot topic has been human decision making. How do individuals evaluate the benefits and risks of different options, what kinds of personal traits guide us to choose certain alternatives and what larger scale systematic decision making patterns exist, are some of the questions behavioural economics and finance attempt to answer.

The approach to examine such questions has originated in psychology and revolves around comprehending different “heuristics and biases” that we humans demonstrate, by acting against a rational, economic value -maximising decision making which the more orthodox economics literature argues for.

Studying the synapse, and specifically chemical synapse this week, got us thinking about the links this neural could have with our decision making capabilities. Of course the most obvious connection is that in the first place, synapses are the basis for many of our cognitive abilities!

By a quick google search, however, we also found some interesting research on how different neurotransmitters affect our behaviour and decision making. For instance, Gaalen et al. (2006) studied how dopamine-related processes affect impulsive decision-making in rats. Their results showed that the rat’s ability to restrain from instant gratification, and therefore make a less impulsive decision, depended on the activation of their dopamine D1 receptor.

The study mentions that such understanding is important, for instance, for comprehending conditions such as ADHD or ADD. But these learnings perhaps speak also to the behaviour of larger groups and could help us understand why some people choose to make impulsive decisions on the stock market. One can therefore build interesting bridges between the two courses and topics!

 

Buy Na and K, not Gold or Silver!

When people think about (precious) metals they can buy to diversify their investment portfolios (to have a more crisis-safe place to put their hard earned savings in), the two obvious candidates are usually: gold and silver.

As we’ve recently learned in our course, however, there seem to be two much more valuable elements to keep an eye on: sodium (Na) and potassium (K) . Perhaps not from an investment, but at least from a neuroscience perspective.

While gold and silver are mainly shiny and look pretty, sodium and potassium have some real superpowers that we experience every day without even paying attention to: they are the main drivers of our neural impulses, or action potentials. Without sodium and potassium cations our neurons would not be able to generate & maintain their membrane potential and, when the neuron is being excited above threshold, change it in milliseconds to propagate a nerve impuls forward: we see, feel, hear, move, or think.

We take our hard earned savings and buy gold & silver with it. Literally every part of this sentence was enabled by sodium and potassium. The working, the thinking, the moving, and even us writing this blog post about it.

Time to give them the attention they deserve!

About us

The human brain is a remarkable thing – already the fact that we are using the very same organ to study it itself is quite unique! That’s one of the reasons why we are pretty pumped to get to study such a topic at Aalto.

We are Philipp and Laura, MSc. students in Finance, who are curious about learning how this “thinking-machine” works beyond the classical business study horizon.

We are especially interested in understanding what scientific discoveries of the brain can teach us about behaviour of individuals in the world of business and finance. We have therefore decided to join our “Finance-Forces” and reflect on thoughts, links, and applications of the study of the human brain from a (Behavioral) Finance perspective in this blog.

We are currently both enrolled in the Behavioral & Sustainable Finance course at Aalto BIZ and hence studying a similar topic from two different perspectives. We hope that our blog posts can provide some enriching insights into how Business and Finance view and deal with the human brain and the behaviors, biases, and unknowns arising from it. And on the other hand, we hope to also explore what new realms are emerging in the intersection of brain and financial research, and what exciting possibilities might pop up because of this.

First published 13.09.2020 on https://blogs.aalto.fi/brainomics/about/.