Behavioural Finance as the Study of the Effects of Emotions - Assignment Example

Behavioural Finance Behavioural finance is a field that involves the study of the effects of emotions, and emotional factors that come into play when making a financial decision. Standard economics has been at the forefront in the analysis of human behaviour in the market, and other financial institutions. This means that it is the one method that has been in use for the longest time to determine why some things are considered rational when it comes to making business decisions, or sometimes irrational. However, over the recent past, neuroeconomics has been the new way to go about trying to relate human behaviour to the financial decision making process. This is by looking at how the brain functions whenever it involves any decision making. Neuroeconomics suggests that when faced with the option of making a choice, the brain often triggers the response needed. Standard economics involves the use of models and theory to try and connect the reality using the variables present in the environment at the time (Tom, Fox, Trepel and Poldrack, p. 45). These variables include supply and demand, price, and quantity present in the economy. This paper will review the implications brought on by the use of neuroeconomics in society, and some of its results. Neuroeconomics has been seen to use research and medical tools to prove their findings about the human and financial decision making process. This is unlike the ordinary standard economics which uses basic models and theories, as seen above. Rationality is the only theory that the two, standard economics and neuroeconomics, seem to support (Takahashi, p. 29). This is seen with the approach, and stand they have taken. Standard economics has indicated that all those in the economic sector are rational, while NE suggests that all of them are irrational in their decision making. The combination of human physiology and economics has helped neuroeconomists to make their case against the standard economic theories. They strive to explain how the human mind and other factors play a role in the financial decision making process an individual has to undergo. What the above implies is that irrationality leads them to be blinded in their financial decision making. This is because human emotions and fears cloud their judgement. NE talks of ways of overcoming these fears, and emotions so as to become rational in the market sector. Rationality has been defined as the balance of a number of components of the brain. When this balance changes, then the rational behaviour in an individual becomes maladaptive (Camerer, p. 67). This means that, the factor that leads an individual to have these characteristics is the immediate surroundings, or their immediate environment. Would it be safe to assume that humans are wired in a certain way? Would it be safe to also assume that the wiring effect has an impact on the financial decision making process of an individual? Arguments brought on by NE suggest that humans are indeed wired in a certain way. It also suggests that the wiring effect has an impact on financial decision making. SE, on the other hand, implies that financial judgement cannot be affected by this wiring effect (Camerer, p. 53). There is no place for the human mind to be affected when making financial decisions. This is due to its argument about rationality. Since humans are always trying to maximise their utility they, therefore, leave no room for irrational tendencies. NE does not think that the theories that SE supports explain the human responses to the financial decisions individuals make. Standard economics is only interested in the outcome of the human behaviour. Neuroeconomics is concerned with what brings about the outcome, and the final decision (Cunningham, p. 38). Outcome is often perceived to change with the decision making process. This is what NE strives to prove, and that is what it claims SE cannot do. Those against NE have assumed that it cannot have a legitimate claim since it has no proven model to support its theory in this modern time. Those for it believe that it is practical since it is no longer standard to make a financial decision, rather, an impulsive reaction on the part of those involved. The impulsive reaction is often as a result of how their rationality is affected, and the individuals’ ever-changing environment. NE has resorted to the use of science. This is to prove that people are indeed wired in the manner in which they make their financial choices, and decisions. Neural activity in the brain has been studied whenever there are choices needed to be made. This activity is monitored as certain parts of the brain are affected when certain tasks are needed to be performed. At this stage, different behaviours are exhibited by the individuals being monitored (Glimcher, p. 48). There are certain chemicals that the brain releases when subjected to certain decision making options. The tests carried out to monitor such neural activity have specialists working to see the different reactions by these individuals. Examples of such chemicals released include dopamine and serotonin. These two are released by the brain, and usually play an intricate role in the decision making process. The Nucleus accumbens and the anterior insula are often also released. These are assumed to be the chemicals that are capable of making an individual take financial risks. They are considered as chemicals responsible for the human risky behaviour when it comes to financial decisions (Glimcher, p. 50). The nucleus accumbens are responsible for recognizing the patterns present to help them make the financial decisions presented. The release of dopamine is brought about by the recognition of a pattern, usually when there is uncertainty present in the said situation. In the event that monetary reward is provided, these chemicals are also released. This brings on the assumption that there is a co-relation between the human physiology, and monetary rewards. Dopamine is triggered due to the reward system. Human emotions then come into play, for example, joy, happiness, and even pleasure. It is highly likely that emotions play an intricate role in the financial decisions made by individuals. If a certain decision does not go as planned, there is the build-up of anger, and frustration (De Martino, Camerer, and Adolphs, p. 66). This is brought on by the anterior insula. In the brain, the release of serotonin, a chemical that is often released, is reduced. NE tries to assume that the brain cannot be not wired to suit, and understand SE, rather, it is wired to deal with, and handle situations as they appear. Neuroeconomics assumes that emotions defy the theories put across by SE. This is because emotions lead to the decisions and choices made by individuals. Emotions such as greed, anxiety, fear, and/or happiness lead an individual to make impulsive decisions about their financial situations. With such emotions in play, there is no room for rational thinking as standard economics suggests (Spinella, Yang, and Lester, p. 50). An example of a financial situation that can fully defy the theories put forward by SE is the recent financial crisis. It shows of the failure by human beings to apply the standard economic theories to real life situations. There are also the reactions that involve risk about financial choices that prove individuals are indeed wired. Many factors come into play when making financial decisions. These factors are either internal or external. An individual’s personality is one internal factor that comes into play when making financial decisions (Fiorillo, p. 36). The external factor could be the environment where the individual is situated, at the time of decision making. These factors come into play, and more often than not, affect an individual’s decision making. This is another theory that suggests that people are indeed wired. There has been evidencing that suggests neuroeconomic theories about people being wired are not logical. This is since the research has not been deemed conclusive. This means that the research findings have not been accurate about the human behaviour in relation to the financial decision making process. Also, being a new field of study, the public has not been introduced to the effects of using some of the methods used by neuroeconomists to come up with their findings (Faruk, p. 34). Such methods include the use of Functional Magnetic Resonance Imaging (FMRI). It is often used to track blood flow in the brain. There is also Positron Emission Topography (PET). This is also used to measure the flow of blood. These techniques have not been proven to be entirely safe, as a lot could go wrong during these experiments. Since there is no way of knowing exactly how researchers do these experiments, it is very easy for the public to be manipulated in believing this method is unique. Another possibility that the experiments are often hastily done to draw conclusions is the element that suggests that these theories are not to be followed. The lack of regulations has led this to be the norm in the neuroeconomics field of research. Another area where NE theory seems to be questioned is the exact role it plays in the financial arena. It seems to be more intrigued by the human physiology more than it is on economics. NE seems to be more concerned with human emotions and has made it its main focus (Spinella, Yang, and Lester, p. 59). Critics argue that what NE is based on is clinical, whilst SE struggles to create assumptions that are based on research previously carried out. This is the difference brought on by the two types of fields. It is the assumption by those who support standard economics that neuroeconomics seeks to find what has already been found, and proven. The only difference is the manner in which they go about it. This is with the use of experiments and science. Solutions neuroeconomics comes up with have already been tested and proven by research that standard economics has conclusively researched on, and reported. The different findings and research NE has come up with has led to the criticism that it may be receiving. In conclusion, it is clear to see that neuroeconomics has established a very clear case against standard economics. This is with the research finding on how individuals’ brains play a crucial role in the financial decision making process. As standard economics research does not give conclusive evidence as to how decisions are made, it is only fair that people understand, and follow NE findings. Proof offered by NE is enough to make people understand that without emotions an individual’s mind is not capable of making financial decisions (Faruk, p. 49). It helps to explain the decisions that are made in the world today. It helps one to know, and understand how these decisions affect the individuals making them, and all those around them. With a close look into how this research can help individuals make better financial decisions, the world’s economic problems would help to be solved, hence, improving many lives. Bibliography Camerer, C. F. Progress in Behavioural Game Theory. New York: Free Press, 1997. Print. Camerer, C. F. Behavioural Game Theory. London: Sage Publications, 2003. Print.  Cunningham, L. A. Behavioural Finance and Investor Governance. New York: PULP, 2002. Print. De Martino B., Camerer C. F. and Adolphs, R. Amygdala Damage Eliminates Monetary Loss Aversion. Cambridge: Cambridge University Press, 2010. Print.  Faruk, G. Behavioural Economics and Game Theory. 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R., Trepel, C. and Poldrack, R. A. The Neural Basis of Loss Aversion in Decision-Making under Risk. New York: Free Press, 2007. Print. Read More