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Brain Regions Blamed for Bad Investment Ideas
Aug. 31, 2005 - A new discovery may help explain where boneheaded investment ideas and get- rich-quick schemes come from.
Researchers say two different brain regions may be involved in making risky vs. conservative investment mistakes, a finding that may eventually help economists build better models of people's investment behavior.
"Overall, these findings suggest that risk-seeking choices (such as gambling at a casino) and risk-averse choices (such as buying insurance) may be driven by two distinct [brain regions]," write Camelia Kuhnen of the Stanford University School of Business and colleagues in the Sept. 1 issue of Neuron.
They say activating either of these two areas can lead to a shift in risk preferences, which may explain why casinos surround their guests with reward cues, such as inexpensive food, free liquor, surprise gifts, and potential jackpot prizes.
This anticipation of reward stimulates the risk-seeking area of the brain and may increase the likelihood of individuals switching from conservative, risk-aversion investment behavior to risky investment behavior. A similar story in reverse may also apply to marketing strategies used by insurance companies.
Where Bad Investment Ideas Come From
In the study, researchers used brain imaging to analyze brain region activity in a group of adult volunteers who were asked to make investment decisions between two stocks and a bond by pressing a button.
Before each session, researchers told the participants they would receive a percentage of the cash that they made by investing or would lose cash from their participation fee if they were not successful.
In each session, the bond was a safe but conservative investment, and the stocks were randomly designated as a "bad" stock likely to lose money or a "good" stock that was more likely to make money.
Researcher scanned the participants' brains as they went through a variety of investment decisions between the stock pairs with and without the bond option and learned the results of the choices.
The results showed that brain activity in certain specific regions tended to activate before participants made risk-seeking investment mistakes, such as opting to invest in a stock whose history was shown to be bad.
In contrast, other specific brain areas were activated before the participants made conservative, risk-averse investment mistakes, such as investing in a bond when they could have invested in a good stock.
Researchers say activating either of these brain regions can lead to a shift in a person's normal risk preferences and lead to investment mistakes.
"Thus, financial decision making may require a delicate balance -- recruitment of distinct [brain] circuits may be necessary for taking or avoiding risks, but excessive activation of one mechanism or the other may lead to mistakes," write the researchers.
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