What happens inside investors’ brains as bubbles form in asset markets? A new study from researchers at Caltech and Virginia Tech offers some insights into the answer to that question.
The researchers created a model market in which subjects could buy, sell, or hold shares of an asset at various intervals, the Pasadena Star-News reports. “The study found two distinct types of activity in the brains during their investment decisions,” writes the Star-News’ Adam Poulisse. “In one, a small fraction of participants were nervous and were prompted to sell their experimental shares with prices on the rise. Others got greedy and were investing aggressively during the bubble and after the peak. Those who got nervous early pulled out, bursting the bubble and earning the most money.”
Sign up for The Guru Investor’s FREE Weekly Newsletter
“The study showed that those who knew to pull out displayed more activity in the nucleus accumbens area of the brain,” Poulisse adds. “The research also hypothesizes that the warning signal begins in the insular cortex, or insula, which has previously been linked to financial uncertainty and risk aversion.”
Caltech’s Alec Smith said the nucleus accumbens activity is a sort of crash predictor. “Nucleus accumbens activity is high when prices are high, and low when prices are low, and tends to predict crashes when we look within a given market,” he said. “We think that the (insula) involves interoceptive awareness, which means awareness of bodily states, or gut feelings.”
