Traders’ brain scans show signals used to build bubbles
The same brain functions that enable people to be socially successful also may lead to financial ruin, according to a study.
The ability to understand the intentions or thoughts of others, known as “theory of mind,” is a fundamental tool of social interaction.
As financial bubbles form, activity is heightened in the area of the brain associated with theory of mind, according to a study of 21 men participating in experimental markets. The research, led by Benedetto De Martino at the California Institute of Technology, was published Wednesday in the journal Neuron.
The finding, coming five years after the collapse of Lehman Brothers Holdings Inc., adds to other research in behavioral finance and economics that seeks to explain the markets.
Andrew Lo, a finance professor at the Massachusetts Institute of Technology, showed in an earlier study that emotions, namely fear and greed, rather than rationality plays a significant role in traders’ decision-making, as observed in responses such as heart rate and blood pressure.
“We’ve shown that an ability that is normally beneficial in social settings, within complex systems, like financial markets, can result in unproductive behavior,” said De Martino, who now is a senior research fellow at Royal Holloway University of London.
In bubble situations, traders “become less driven by explicit information, like actual prices, and more focused on how they imagine the market will change,” he said.