For the inaugural blog post of the WEE, we thought it would be a good idea to give a short summary of Colin Camerer’s collaboration paper: ‘Irrational exuberance and neural crash warning signals during endogenous experimental market bubbles’.

As is the trend with Neuroeconomics, the title of most published papers seem both intimidating and inaccessible to the economist not trained in the dark arts of neurobiology. However, that’s where this blog post (and Wikipedia, really) comes in. We lay out a brief motivation of the paper, their experimental methodology and an even briefer discussion of results; our own aim being to make papers such as this more accessible.

It is quite easy to think of many instances where groups of people misalign value to assets, leading to price bubbles such that the price rises far above fundamental values. There are many psychological reasons that have been suggested in the past (and as the paper notes) such as ‘euphoria’, ‘irrational exuberance’, ‘animal spirits’ etc. However, we don’t really have a good idea of how to incorporate these ideas elegantly into our models. Also, the connection between neural responses and behavioural acts in such situations has so far not been studied owing to technological constraints. fMRI technology allows us to study neural activity non-invasively and is surprisingly much more acceptable than inserting electrodes into conscious, human brains.

The motivation of the paper is to get a better idea of the behavioural and neurological processes at play in human subjects in an experimental asset market. An experimental setup such as this affords the experimenter the ability to define a risky asset that has an unambiguous fundamental value – something that is extremely rare in field data. The market was so defined that endogenous price bubbles could exist and with 2-3 participants, out of 20 in each session, hooked up to a functional MRI machine. The neural activity of the participants along with the market price fluctuations, behavioural acts (buying/selling) and earnings were recorded. Do take a look at the exact experimental methodology in the paper – those interested in finance will find it quite interesting.

Well, what did they find? Before we get there, it might be good to describe the relevant brain regions in brief. The Nucleus Accumbens “…has a significant role in the cognitive processing of motivation, pleasure, and reward and reinforcement learning, and hence has significant role in addiction.” And, the anterior insular cortex is an area that deals with emotional awareness and is active during negative emotional states and bodily discomfort.

[Aside: this type of information is easily available on Wikipedia and a great starting point when dealing with unfamiliar terms associated with Neuroeconomics]

The study found that the activity in the nucleus accumbens (NAcc) tracks the price bubble and aggregating the NAcc activity across participants predicted future prices changes and crashes. Furthermore, there were significant differences between the brain activity of the highest and lowest earners. The lowest earners tended to buy as a function of the NAcc activity. However, the highest earners had activity in the anterior insular cortex that preceded the price peak. Given that the highest earners tended to sell before the bubble burst, this could be a neural early warning signal in such people!

These are exciting times for the study of Neuroeconomics and the study of decision making as a whole. Perhaps a more thorough understanding of brain activity, the biological constraints of our neural hardware and the underlying processes at play can help us build better predictive models of human behaviour. The physical manifestations of decisions might serve as guideposts in our unrelenting quest to understand how, what and why people make the decisions they do.

Hopefully this blog post has motivated you to read the original paper in all its glory (it’s only 6 pages), critique it and given you confidence to venture a look at other similar papers.

Useful links:

  1. Original Paper:
  1. Marr’s 3 Levels of Analysis:
  1. What is fMRI?
  1. An interesting perspective on how Neuroeconomics can tell us about economics:

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