The Influence of Affect on Beliefs, Preferences, and Financial Decision
Brilliant paper concludes, ” outcomes of past choices may change emotions and thus influence future financial decisions.”
Abstract (Via Kellog)
Neuroeconomics research shows that brain areas that generate emotional states also process information about risk, rewards, and punishments, suggesting that emotions influence financial decisions in a predictable and parsimonious way. We find that positive emotional states such as excitement induce people to take risk and to be confident in their ability to evaluate investment options, while negative emotions such as anxiety have the opposite effects. Beliefs are updated such as to maintain a positive emotional state by ignoring information that contradicts individuals’ prior choices. Marketplace features or outcomes of past choices may change emotions and thus influence future financial decisions.
Introduction (Via Kellog)
The goal of this paper is two-fold. First, we would like to find out whether emotions change financial choices by modifying risk preferences, or beliefs, or both. In an experimental setting, we observe financial choices and also elicit subjective beliefs about the payoffs of the available investments. Changes in emotional (or affective) states are either induced exogenously, or are the result of the investing activity itself. Second, we pro- pose a parsimonious framework for explaining multiple types of deviations from rational choice, or behavioral biases. We build this framework on the existing results regarding the role of the emotional brain on decision making. Our main insight is that emotions matter for decision making under risk, whether they are caused by exogenous factors or induced by outcomes of past choices. In particular, we argue that two emotional states, excitement and anxiety, influence our risk preferences and the way we learn.