Why biology may be responsible for bubbles, booms and busts
Five years since the financial crisis, we have had ample occasion to ask the question: what were the people on the trading floors of global finance thinking?
Now scientists think they may have the answer.
The decisions and behaviour that led to market bubbles and financial crashes may have their origins in instinctive biological mechanisms in the brain.
In the first study of its kind, researchers at the California Institute of Technology (Caltech) teamed experts in finance with neuroscientists to investigate whether the brain's activity during the trading process might lead to apparently irrational investments.
The study, part-funded by the Wellcome Trust, was published yesterday in the journal 'Neuron'.
Working with a team of volunteer students and using functional Magnetic Resonance Imaging, which can detect changes in blood flow in the brain, researchers observed that the creation of market bubbles was closely associated with heightened activity in two parts of the brain.
People who had greater activity in the area of the brain that processes value judgements were more likely belatedly to follow market trends and lose money by paying more for an asset than its fundamental worth. Intriguingly, greater activity was also observed in the part of the brain that interprets social signals to predict the behaviour of others.
Scientists suggested that this instinctive mechanism could lead to distorted judgements when applied to a "complex modern system, like financial markets".
Dr Benedetto De Martino, a researcher at the Department of Psychology in the Royal Holloway University of London, who led the study while at Caltech, said: "They start trying to imagine how the other traders will behave and this leads them to modify their judgement of how valuable the asset is."
The research team at the university found that when participants noticed a disparity between how much they perceived an asset to be worth and the rate of transactions for that asset, they made poor business decisions and bubbles started forming in the market. (© Independent News Service)