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.

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