The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Thursday, April 20, 2006

Tyler Cowen on Neuroeconomics in the New York Times

I just read Tyler Cowen's, an economist at George Mason University, 'Economic Scene' column in the New York Times. He wrote a piece on the new and exciting field of neuroeconomics: Enter the Neuro-Economists: Why Do Investors Do What They Do? (NYT, April 20, 2006).

Here are some snippets from the article:

For the first time, economists are studying these phenomena scientifically. The economists are using a new technology that allows them to trace the activity of neurons inside the brain and thereby study how emotions influence our choices, including economic choices like gambles and investments.

For instance, when humans are in a "positive arousal state," they think about prospective benefits and enjoy the feeling of risk. All of us are familiar with the giddy excitement that accompanies a triumph. Camelia Kuhnen and Brian Knutson, two researchers at Stanford University, have found that people are more likely to take a foolish risk when their brains show this kind of activation.

But when people think about costs, they use different brain modules and become more anxious. They play it too safe, at least in the laboratory. Furthermore, people are especially afraid of ambiguous risks with unknown odds. This may help explain why so many investors are reluctant to seek out foreign stock markets, even when they could diversify their portfolios at low cost.

If one truth shines through, it is that people are not consistent or fully rational decision makers. Peter L. Bossaerts, an economics professor at the California Institute of Technology, has found that brains assess risk and return separately, rather than making a single calculation of what economists call expected utility.

The Times' piece goes on to discuss Andrew Lo (of MIT's) work in this area: e.g., The Psychophysiology of Real-Time Financial Risk Processing, with Dmitry V. Repin, Journal of Cognitive Neuroscience 14(2002), 323-339. Although, strictly speaking, it's not really neuroeconomics (it's more like physio-economics or perhaps cognitive economics), I thought it was interesting research when I first came across it a few years ago.

Prof. Cowen adds some wise words of caution regarding the possible applicability of neuroeconomics:
[T]he setting may matter. Perhaps we cannot equate choices made on the New York Stock Exchange trading floor with choices made under a hospital scanner, where the subject must lie on his back, remain motionless and endure a loud whirring, all the while calculating a trading strategy.

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