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Zack Lynch is author of The Neuro Revolution: How Brain Science Is Changing Our World (St. Martin's Press, July 2009).
He is the founder and executive director of the Neurotechnology Industry Organization (NIO) and co-founder of NeuroInsights. He serves on the advisory boards of the McGovern Institute for Brain Research at MIT, the Center for Neuroeconomic Studies, Science Progress, and SocialText, a social software company. Please send newsworthy items or feedback - to Zack Lynch.
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October 29, 2003

Finance with Feelings

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Posted by Zack Lynch

In Second that Emotion, economic commentator James Glassman discusses how several mutual funds are using techniques pioneered by behavioral economists to help take into account emotions in financial markets.

Behavioral economists have shown that, under some circumstances, people aren't rational actors in their economic decision-making; they are influenced heavily by their emotions. So as Glassman put it, "How do you fight emotional, irrational responses to financial stimuli?"

One answer he gives is "mean reversion." But with emerging neurotechnology the answer could be quite different. For instance, traders could be given emotional forecasting feedback and neuroceutical tools to adjust their perception of future events.

Here is a simplistic thought experiment on how neurotechnology might play a role:

1. Reduce overestimation with real-time impact bias feedback: The gap between what we predict and what we ultimately experience is the ''impact bias'' -- ''impact'' meaning the errors we make in estimating both the intensity and duration of our emotions and ''bias'' our tendency to err.

To predict correctly how they will feel about their decision some time after it occurs, people need to know: the acceleration of their initial emotional reaction, the peak level of intensity of their reaction and the rate of deceleration. People almost always overestimate the rate of acceleration, overestimate the peak level of intensity and underestimate the rate of deceleration of the pleasure that their decisions gave them.

As George Lowenstein, an expert in emotional forecasting points out, ''If you had a deep understanding of the impact bias and you acted on it...you would tend to invest your resources in the things that would make you happy." In short, financial traders would perhaps make decisions that were more in-line with longer-term satisfaction and financial returns.

2. Reduce empathy gap by stabilizing emotional states: The "empathy gap" is the difference between how we behave in "hot'' states (those of anxiety, courage, fear, and the like) and ''cold'' states of rational calm. Our empathy gap impacts our thoughts and behaviors to the point where we cannot seem to predict how we will behave in a hot state when we are in a cold state.

Emoticeuticals that would be triggered when a trader was in a particular "hot" state that could remind them of the consequences of making a trade when they are in a particular state. The baseline for the trigger might be a complex of multiple "hot" states that the trader would determine was most appropriate for them based on their trading history and when they have made poor decisions.

Clearly the above example is simplistic. It is a thought experiment on how financial trading might be impacted by neurotechnology. More to follow.

Comments (4) | Category: Neurofinance


COMMENTS

1. Paul Zak's on November 3, 2003 8:48 PM writes...

I asked Paul Zak to comment on this piece. Here is his response via email:

Z: have you seen the paper by Lo & Repin that wired up prof. traders in the field with psychologic measures and see what happened with market volatility? Nice paper in J. Cog. Neurosci. These traders either by training or self-selection, were able to show less emotional response to market volatility.

These seems to me to be endogenous emotional
repression (by the way, fMRI studies by Canli et al on repressing emotional responses show that this takes alot of brain power). So, if an emotoceutical can make this more efficient (i.e. cognitively cheaper) then this would be useful--except if one were challenged...due to side effects.

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2. Paul Zak on November 3, 2003 8:50 PM writes...

Another thought from Paul:

...the neurocueticals and productivity seems straightforward: on during work, off after work, better focus. Affective forecasting...I'm not sure how this is defined, sort of a biofeedback? How would the feedback be presented? There is a place up by you called Institute of HeartMath that seems to make a living on training folks to be more focused by reducing heart rate variability (guess what, oxytocin is a major heart neurotransmitter--of course!).

I did their training (we've talked about joint research), easy, but of course harder to stay in the groove all the time. Check out their website. Could affecting forecasting do this in real time?

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3. Dr. Ken Celiano on January 17, 2004 10:56 AM writes...

I am a psychologist in Chicago on the cusp of potentially impacting traders at the CBOT & CME with better emotional management via HeartMath's "Freeze-Frame" process in order to improve trading performance by better managing the intrusion of negative emotional intensity during real-time decision-making periods. I would be very interested in maintaining a dialogue with you and your colleagues on relevant applications to better trader performance. My clinical training is in emotional intelligence training and health psychology, with strong neuropsychological roots. FYI, I came across your site via google search and very glad I did. I wish you continued persistence in this interesting area of study.

Regards,
Dr. Celiano

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