insight into investor behavior, Kellogg finance professor
finds that a journey into the primitive brain pays dividends
© Nathan Mandell
Donald P. Jacobs Scholar in Finance Camelia
Kuhnen is not most scholars. A senior lecturer at the
Kellogg School, Kuhnen is a pioneer in neurofinance, an emerging
field that explores the intersection of neuroscience and economic
theory. She became curious about the implications that the
one discipline held for the other during her undergraduate
career at MIT, where she double-majored in neuroscience and
finance, and began to splice the two subjects while earning
a doctorate in finance from Stanford University's Graduate
School of Business.
is one of the only finance scholars in the world likely to
note as an aside that "uncertainty correlated maximally
and negatively with bilateral anterior cingulate foci"
in the brain-imaging experiment she developed, but like others
in the field, her focus on practical matters is sharp. "The
Neural Basis of Financial Risk Taking," the study she
completed with research partner Brian Knutson at Stanford,
appeared in the September 2005 issue of Neuron magazine.
The magazine's cover is taped to her office door.
asked to describe her research in terms a layperson could
understand, Kuhnen begins with a brief lesson in neurology.
She opens a laptop and pulls up an MRI image of a brain, a
thin slice of data taken from deep within. The prefrontal
cortex — the region of the brain associated with reason,
long-term planning and cognition — is nowhere to be
seen. The slice on display here is older, simpler, closer
to the spinal column. Two small areas near the center are
aglow with activity.
points to the image on the laptop screen. This is a view of
the limbic system, she says, the primitive, emotional part
of the brain. Because economic theories tend to hinge on the
presumed rationality of relevant actors, she notes, economists
have not traditionally had much use for the limbic system.
She indicates the two bright spots among the gray matter.
One is the nucleus accumbens (NAcc), which motivates people
to seek reward. It lights up when a hungry person sees a fruit
tree or a chocolate cake in the distance and seems to encourage
quick action to procure the food. If a hungry man is sprinting
toward an apple orchard, says Kuhnen, his nucleus accumbens
is almost certainly charged with purpose.
other active area on screen is the anterior insula —
the limbic system's wary answer to the NAcc. The anterior
insula is concerned not with seeking reward, but with avoiding
risk. If a snake slithers up to the hungry man in the apple
orchard, activity spikes in the anterior insula, prompting
him to run for his life.
areas "deal with gut feelings" of one sort or another,
what could these primitive impulses possibly have to do with
high-level cognitive processes like picking a winner on Wall
Street or managing a blue-chip portfolio? According to Kuhnen,
there is no escaping the fundamental risk/reward functions
of the limbic system. "It kicks in even if the situation
is not about running for food or running away from snakes,"
returns to the study featured in "The Neural Basis of
Financial Risk Taking." Participants were asked to perform
a simulated investment task while under observation in an
MRI machine. The experiment offered subjects choices between
"good" stocks and "bad" stocks (the "bad"
being more likely to yield negative returns and less likely
to yield positive ones than the "good") while equipment
monitored and recorded activity in the NAcc and the anterior
people rely on both areas to help them decide quickly what
to risk in pursuit of rewards, the gut (i.e. the jumpy limbic
system) is not always the most helpful tool to the modern-day
savvy investor. "The more activation you have in these
two areas, the more likely you are to make a mistake,"
says Kuhnen. The mistakes Kuhnen's and Knutson's investors
made fell into two neat categories, each perfectly avoidable
to the rational actor. Subjects who were too risk-averse were
shown consistently to be impaired by an overactive anterior
insula at the time they made the poor choices, and subjects
who mistakenly took too many risks were operating under the
influence of excess NAcc activity.
the consistency of these results, Kuhnen theorized that she
and Knutson would be able to predict not only when a subject
was about to make a mistake, but also what sort of mistake
(risk-seeking or risk-averse) it would be. To test their hypothesis,
they began to measure activity in each area two seconds before
each choice was made. It turned out, says Kuhnen, that the
experimenters could indeed make meaningful predictions about
the body of neurofinance research is small, its implications
could be large for economists and individual investors. "Once
you have this model, you know what's inside the 'black box,'"
Kuhnen says. If investors can understand their most basic,
least rational motives, they can begin to find ways to compensate,
or attenuate, bad choices. For the prudent investor, Kuhnen
says even something as simple as acknowledging that "it's
sunny outside and you're happy" (and therefore more likely
to feel biologically driven to a gamble) might help prevent
a risky mistake on the trading floor.
adds that, pending further research, academics in finance
and related fields may find themselves adding a whole new
dimension — the possibility that investing is more than
a game of numbers, whether or not investors know it —
to their research: "If we write theory models of choice,
we should be motivated to include affect and emotions [as
research on neurology and financial decision making continues.
With co-authors from Stanford University and the University
of Washington, she is exploring the effects of aging on financial
choices. Since many studies have shown that aging affects
the brain, says Kuhnen, it will be valuable to know whether
age-related physiological changes also influence financial
choices. "[The results] may inform policymakers when
it comes to issues like privatizing social security,"
says more research is necessary. "I cannot tell you a
trading strategy based on this [set of findings]," she
says, but the MBA student or investor would do well to "be
aware that affect plays a role" in financial decisions
to avoid dismissing the subtly powerful force of the primitive
brain. After all, it has kept humans running in the right
direction — toward fruit, away from venomous reptiles
— long before any of them claimed to be rational.