Behavioral Finance 201: Normative Finance Deprogramming by Kihn John

Author:Kihn, John [Kihn, John]
Language: eng
Format: epub
Publisher: Unknown
Published: 2015-10-25T16:00:00+00:00

2. Characteristics derived from brain scans matter (yet should not)

"Numerous theories on decisions to invest on capital market are put in difficulty, if we are looking from the perspective of neuroeconomics. This is because the decisions that investors take are very often irrational and inconsistent with these theories. Such irrational behavior of investors may be generated by their personality, emotions, temper with their feelings."

Ciobanu and Sechel (2012, p. 86)

"Neuroeconomics " can be considered responsible for prodding economics, and especially finance, to consider characteristics (especially at the individual level). Currently, when neuroeconomics is considered, probably most people first consider cognitive neuroscience. Cognitive neuroscience examines questions concerning how psychological and/or cognitive functions are produced by human neural circuitry. Probably the most common images today are the measurement techniques associated with various forms of “brain scanning” devices (e.g., fMRI – functional Magnetic Resonance Imaging, PET – Positron Emission Tomography, etc.). Much of the work to date has indeed focused on using such techniques to identify and map areas of the human brain (i.e., map the specific neural circuits) that are used to address questions of economic choice (i.e., choice behavior as it relates to economics). Clearly, the ability to directly measure thoughts and feelings or sentiment should be extraordinarily useful in analyzing decisions and choice, especially in finance and economics.

One fundamental example of neuroeconomics as applied to economics is as applied to inter-temporal decision making (e.g., discounting cash-flows). [206] At possibly the most general level one can think of the human brain as being composed of at least three overlapping, yet mostly separate parts:

1) The reptilian complex or “lizard brain” controls such things as breathing, physical movement, sight, etc.. Essentially it is responsible for most of the basic bodily functions, but also can cover things like anger and fear. Physically it sits atop the spinal cord.

2) The “dog brain” or limbic system controls emotions such as loyalty and lust. Physically it mostly sits atop and surrounds the lizard brain.

3) The neo-cortex is where things like logic and reason reside. Relative to the other two it is physically larger, more complex and sits atop and mostly surrounds the other two.

Why might it be important to know we have three brains? Because each can have, for example, an impact on the discounting of cash-flows. [207] They can appear to act independently, but they are in fact semi-independent. Thus, we can under one set of conditions when the lizard brain dominates suffer from overwhelming fear and excessive or impulsive discounting of future cash-flows. Under another set of conditions when the "dog brain" dominates one might be very optimistic and largely ignore the probability of negative outcomes (and subsequently under-discount future risky cash-flows). [208] It has been found that more addictive personalities do not prefer delayed gratification and thereby strongly skew decision making (and discounting) toward the immediate versus the delayed. It is the interaction and domination of the various parts of our minds that determine our time preferences (again, depending on the condition(s)) and largely results

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