Neurofinance: Money, Risk and the Brain
Abstract (Via Kellog)
In the past few years neurofinance has emerged as a new field in economics and finance. The small but growing number of economists and neuroscientists involved in this new field have a common goal: to understand how people make economic decisions by analyzing how the brain works when these choices are made. The rise of the field was generated by the failure of the standard rational agent model used by economists in the last 50 years to explain a significant number of decisions made by individuals. Deviations from the optimal choices predicted by the standard model have been documented in the behavioral economics and behavioral finance literature for two decades. However, we still do not have a parsimonious new model that can explain all behaviors exhibited by economic agents, including the so-called deviations from those predicted by the standard model.
Introduction (Via Kellog)
Neurofinance (also referred to as neuroeconomics) is trying to provide this new model of economic decision-making, based on how our brain operates when we are faced with choices. The failure of the standard model could potentially be caused by the lack of realism in its assumptions. Tools available to neuroeconomists allow for these assumptions to be tested — for instance, we can find out whether the brain tracks expected values, risk, or inter-temporal discount factors. By looking inside the brain we can create a more realistic model of decision-making which hopefully is both parsimonious, and able to explain a much wide range of individual economic behaviors compared to the standard model. This article will review some of the puzzles (or deviations from the standard model) documented in behavioral economics and behavioral finance, and then describe several neuroeconomics studies that try to explain these puzzles by examining brain activation during decision-making.
Excerpts (Via Kellog)
The potential to use brain scans to learn what people really like, dislike or can do, is the main reason why companies have started to conduct neuromarketing studies and measure brain activation while individuals are presented with various products.
Findings from neuroeconomics can be used by policy makers, too, in order to increase social welfare. For instance, if the government wants to encourage workers to save more for retirement, it may design markets or financial policies that trigger the right part of the limbic system to induce the desired behavior.