Thursday 20 December 2007

Brain Waves

Confidence is often considered a nebulous but crucial aspect of the functioning of markets, particularly financial markets. Feeling is another such concept. Considering financial markets as many neural networks interacting, confidence could be thought of as the emotional state in which they are operating, and feeling as the intuitive grab at what myriad inter-relating factors, too complex in their diversity of level, detail, and certainty to be open to formal, superficial analysis, are presenting every moment.

Advances in neural imaging have demonstrated the profound effects emotional state can have upon intuitive understanding and expressed preferences. Confidence leads to different behaviours from those generated by its absence, depression. Operating with depressed emotions alters the 'grab' of understanding offered by feeling. And actions then ensue that reinforce the pattern.

Most economic analysis treats risk preferences, time preferences and social preferences as separate kinds of preferences, but what if all three share common neural circuitry for controlling automatic emotional impulses - fear, temptation , and selfishness respectively, - by integrating all the costs and benefits of choices.

Standard analysis in game theory assumes players are in equilibrium; yet one study showed the more skilled using different parts of the brain in making choices while the less skilled showed brain activity elsewhere as if strategic uncertainty was causing the feeling of discomfort.

The social neuroeconomists Fehr and Camerer posit that eventually there might be a biological basis 'for a mathematical characterization of social exchange that is rooted in neural details but can also make predictions about activity in strategic interaction and market trading ... 'and, they add darkly, '...about how behaviour can change when causally manipulated by pharmacology, TMS, and other tools .'

9 comments:

Sackerson said...

That's got lots of ramifications. Benjamin Graham stresses that a key element of successful investing is emotional control - a realist can make money buying from pessimists and selling to optimists.

hatfield girl said...

It's at the edge of my grasp, S, but so interesting; the word play suggests this has long been observed behaviour - sentiment, confidence, feeling, spirits animal and rational; I was hoping you and others could impose sage and knowledgeable order in the comments.

Sackerson said...

I like systematising, but now realise it's a weakness as well as a strength. There's an ancient Chinese (Taoist ?) saying, "man is greater than anything he creates". I think life lies in that humility.

Nick Drew said...

I knew you were going to have fun, HG

when causally manipulated - that is dark, isn't it ...

Following Sackers, perhaps the market-maker is the embodiment of arbitrage between optimist and pessemist

I always remember the first big FX dealer I encountered, can't recall which bank - if his book was long he would exude optimism; if short, he'd be a real doom-monger. Actually just a showman, of course

sorry I'm being facetious but hey, tis the Season

will revisit these ideas when I've finished the current essay

Anonymous said...

Optimists, pessimists.
In the old Soviet days they used to say: A pessimist is an optimist who is well informed, an optimist is a pessimist who has been well indoctrinated...

Seriously, HG, you have taken a promising road, but it is hard, hard, hard. Bon voyage.

hatfield girl said...

What happens to people who disagree with ancient Chinese sayings S? There are many things greater than mankind that men have created who no longer exist, or could exist now.

Some of the heroes are like that.

hatfield girl said...

C, are you waving me off or beckoning me on? Which end of the road are you?

Sackerson said...

No penalties, HG. I think that saying is akin to saying a TV screen contains the possibilities of all the pictures ever transmitted, and infinitely more. It's the people who have the answer to mankind - the simple formulation - that you want to watch out for.

I should like to see you expand on what you've been learning about emotion, perception etc - I'm sure we're all waving you on from the roadside.

Anonymous said...

Glad to follow you on that road, HG, but I can't/won't take the lead.

By the way, besides Confidence, Feeling, etc, what about "Market Sentiment"? I always thought it's another way of saying "Things are what they are because this is how the market feels..."