Neuroscience may help us understand financial bubbles. (2013)

“New research suggests market bubbles are driven by a biological impulse to predict others’ behaviour … people are more likely to overvalue assets in a bubble …

Benedetto De Martino, Senior Research Fellow in Neuroeconomics at Royal Holloway

Will de Freitas, Editor, The Conversation

Richard Taffler, Professor of Finance at University of Warwick

The Conversation, 18 September 2013

New research published in the journal Neuron suggests that market bubbles are in fact driven by a biological impulse to try to predict how others behave.

To conduct the research, De Martino, a neuroscientist, teamed up with finance professor Peter Bossaerts and Colin Camerer, a behavioural economist.

The study asked participants to make trades within an experimental bubble environment, where asset prices were higher than underlying values. While making these trades, they were hooked up to scans which detected the flow of blood to certain parts of the brain.

They found two areas of the brain’s frontal cortex were particularly active during bubble markets: the area which processes value judgements, and that which looks at social signals and the motives of other people.

Increased activity in the former suggests that people are more likely to overvalue assets in a bubble. Activity in the latter area shows participants are highly aware of the behaviour of others and are constantly trying to predict their next moves.

“In a bubble situation, people start to see the market as a strategic opponent and shift the brain processes they’re using to make financial decisions,” De Martino 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. They become less driven by explicit information, like actual prices, and more focused on how they imagine the market will change.”

Read the full article here: Neuroscience may help us understand financial bubbles

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