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Neurofinance: The Brain on Money

What is Neurofinance?

Definition: The field combining neuroscience, biology, and finance to understand the physiological basis of financial decision-making. It uses tools like fMRI, EEG, and hormone sampling to see what happens inside the brain when we trade.

Core Finding: The "Rational Economic Man" does not exist in the brain. We are biological machines driven by ancient survival mechanisms.

The Triune Brain in Investing

The Reptilian Brain (Basal Ganglia)

  • Function: Survival, instinct, fight-or-flight.
  • Financial Role: Panic selling (flight) or "revenge trading" (fight) after a loss.
  • Trigger: Sudden market crashes or extreme volatility.

The Emotional Brain (Limbic System)

  • Amygdala: Fear center.
    • Active during: Market drops, risk perception.
    • Effect: Freezes decision making or forces exit.
  • Nucleus Accumbens (NAcc): Reward/Greed center.
    • Active during: Winning trades, bubbles, "hot tips".
    • Effect: Release of Dopamine. Creates addiction-like loops.

The Rational Brain (Prefrontal Cortex - PFC)

  • Function: Planning, logic, math, impulse control.
  • Financial Role: Asset allocation, analyzing balance sheets, sticking to a plan.
  • Vulnerability: Goes offline under stress!

Chemistry of Trading

Dopamine (The Reward Molecule)

  • Role: Anticipation of reward (not just the reward itself).
  • Effect: Buying a volatile stock triggers dopamine. If it goes up, you get a "high."
  • Trap: Investors chase high-beta stocks and lottery tickets to get the dopamine hit, similar to gambling addiction.

Cortisol (The Stress Molecule)

  • Role: Response to chronic stress/uncertainty.
  • Effect: High cortisol (from prolonged bear markets) increases Risk Aversion.
  • Coates Study: Traders with high cortisol became irrationally risk-averse, missing the recovery rally. "The biology of the crash prevents the recovery."

Testosterone (The Confidence Molecule)

  • Role: Dominance, competition, risk-taking.
  • Effect: High testosterone leads to Overtrading and ignoring downside risk.
  • Bubbles: Bull markets boost testosterone → more risk → higher prices → feedback loop.

Neurological Asymmetry (Loss Aversion)

The Brain Scan:

  • Gain of ₹100: Slight activity in NAcc.
  • Loss of ₹100: Massive firing in Amygdala and Insula (pain center).
  • Physical Pain: Financial loss is processed in the same brain region (Anterior Insula) as physical pain and disgust. A loss literally "hurts."

Dealing with Biology

Since we cannot change our biology, we must change our environment:

  1. Reduce Sensory Input: Turn off flashing red/green tickers. They overstimulate the amygdala/NAcc.
  2. Wait 48 Hours: Allow the "chemical storm" (cortisol/dopamine) to subside before executing a non-scheduled trade. The PFC needs time to reboot.
  3. Use Checklists: Forces the PFC to engage ("Do I have a stop loss? Is this in my plan?") interrupting the emotional loop.

Key Takeaways

  • Biological Reality: We are wired for survival (run from pain, chase food), not for stock markets (buy pain/dip, sell food/rally).
  • Amygdala Hijack: Stress physically disables the rational brain.
  • Chemical Drivers: Dopamine drives bubbles (greed); Cortisol prolongs crashes (fear).
  • Pain of Loss: Processed like physical injury.
  • Solution: Design systems that don't require willpower in the heat of the moment (Automation).

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