Your investment portfolio isn’t performing very well, and you’re beginning to wonder about some of your stock choices. Perhaps an fMR scan can help you get a better grip on the situation.
Your investment portfolio isn't performing very well, and you're beginning to wonder about some of your stock choices. Perhaps an fMR scan can help you get a better grip on the situation.
A Stanford University psychology professor and a doctoral candidate in finance have shown for the first time that activation of two parts of the brain linked to excitement and anxiety influence financial decisions - rational and irrational. The findings ultimately could be used to improve the design of economic institutions to help investors make better choices, the researchers said.
"If you read academic finance and economic literature, you see that people don't really accept the notion that affect, or emotion, can play a role when you make economic choices," said Camelia Kuhnen, a doctoral candidate at the Graduate School of Business.
Kuhnen and Brian Knutson, Ph.D., an assistant professor of psychology, carried out the study to find out whether emotion can affect a person when it comes to making investments. They discovered that it does (Neuron 2005;47:763-770).
"People are not as rational as we would like them to be," Kuhnen said. "I`m happy we got these results, because I believe this is evidence that economists should take into consideration when we write investing models for individuals."
Kuhnen and Knutson used fMRI to scan the brains of 19 volunteers as they performed an exercise that required them to choose between two stocks and a bond that offered real financial gains and losses.
The researchers randomly designated one of the stocks as "bad," which was more likely to lose money, and the other as "good," which was more likely to make money. The bond offered a safe but low-return investment.
The study participants, all Stanford doctoral students, were asked to pick between the two stocks and one bond 10 times during 20 separate games. The volunteers did not know which stock was good or bad. They had to figure that out by watching the market.
The researchers looked at blood oxygen level in the nucleus accumbens, which becomes active when someone expects a reward of a primary nature, such as water if a person is thirsty, Kuhnen said. The area is rich in the molecule dopamine and is linked to the addictive effect of drugs.
In past studies, Knutson has shown that the nucleus accumbens also activates if someone anticipates a financial reward, even before he or she actually receives the money.
The two collaborators also charted activation levels in the anterior insula, which is linked to anxiety and lights up when a person sees disgusting, repulsive stimuli, such as mutilated bodies, or when someone anticipates physical pain, Kuhnen said.
They discovered that the nucleus accumbens kicked into action two seconds before subjects made a "risk-seeking" choice that was a mistake - when they decided to invest in a stock even if it had a bad history.
In contrast, the anterior insula was activated just before the volunteers made a less than optimal "risk-averse" choice that prompted them to invest in a safe but low-return bond instead of the good stock. Overall, the study found that volunteers made the rational, optimal choice 75% of the time.
"The findings confirmed our hypothesis that these two areas are involved in decision making," Kuhnen said. "What was most interesting was to look at the activation of these two areas before one makes investment choices. The question is, Can you predict whether people are going to choose a risky investment or a risk-less investment? Can you predict whether people will make a mistake when they choose an investment?"
The researchers noted that institutions encouraging either risk-seeking behavior or risk-averse behavior understand how excitement and anxiety influence people's decisions.
"You go to Vegas, and you are surrounded by all these rewards such as free food and potential prizes," Kuhnen said. "We know from past studies that sights of potential rewards can activate your nucleus accumbens. What this study shows is that when the nucleus accumbens is activated, you tend to be more risk seeking. You tend to choose the stock more often and to choose it when you shouldn't."
An insurance company appeals to opposite emotions.
"If you go to an insurance office, people will show you pictures of crashes or tell you how you could be hurt," Kuhnen said. "We know that such a stimulus might activate your anterior insula. Our study shows that high insula activation is a predictor of making a risk-averse choice."
If the emotional states of individuals are included in rational decision-making models, people will be able to make better financial choices, according to the researchers.
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