The Influence of Affect on Beliefs, Preferences and Financial Decisions

Kuhnen, Camelia and Knutson, Brian (2008): The Influence of Affect on Beliefs, Preferences and Financial Decisions.

Abstract

Recent research in neuroeconomics suggests that the same brain areas that generate emotional states are also involved in the processing of information about risk, rewards and punishments. These findings imply that emotions may influence financial decisions in a predictable and parsimonious way. Our evidence suggests that affect -- generated either by exogenous manipulations, or endogenously by outcomes of prior actions -- indeed matters for financial risk taking, and that it does so by changing preferences as well as the belief formation process. Positive and arousing emotional states such as excitement induce people to take more risk, and to be more confident in their ability to evaluate the available investment options, relative to neutral states, while negative emotions such as anxiety have the opposite effects. Moreover, beliefs are updated in a way that is consistent with the self-preservation motive of maintaining positive affect and avoiding negative affect, by not fully taking into account new information that is at odds with the individuals' prior choices. Therefore, characteristics of markets, economic policies or organization design that have an impact on emotional brain circuits may influence decision making and affect important outcomes at the individual and aggregate level.

• Item Type: MPRA Paper
• Language: English
• Keywords: affect, emotions, beliefs, risk taking, learning, limbic system, neuroeconomics, neurofinance
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; C - Mathematical and Quantitative Methods > C9 - Design of Experiments > C91 - Laboratory, Individual Behavior; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D87 - Neuroeconomics

References

Akerlof, George, and William T. Dickens, 1982, The economic consequences of cognitive dissonance, American Economic Review 72, 307–319.

Barber, Brad, and Terrance Odean, 2000, Trading is hazardous to your wealth: The common stock investment performance of individual investors, Journal of Finance 55, 773–806.

Ben-David, Itzhak, John R. Graham, and R. Harvey, Campbell, 2007, Managerial over-confidence and corporate policies, Working paper.

Benartzi, Shlomo, and Richard Thaler, 1995, Myopic loss aversion and the equity premium puzzle, The Quarterly Journal of Economics.

Bernheim, Douglas B., and Antonio Rangel, 2004, Addiction and cue-conditioned cognitive processes, American Economic Review 94.

Bertrand, Marianne, and Antoinette Schoar, 2003, Managing with style: The effect of managers on firm policies, Quarterly Journal of Economics 118, 1169:1208.

Bjork, J. M., B. Knutson, G. W. Fong, D. M. Caggiano, S. M. Bennett, and D. W. Hommer, 2004, Incentive-elicited brain activation in adolescents: Similarities and dif- ferences from young adults, Journal of Neuroscience 24, 1793–1802.

Breiter, H. C., I. Aharon, D. Kahneman, A. Dale, and P. Shizgal, 2001, Functional imaging of neural responses to expectancy and experience of monetary gains and losses, Neuron 30, 619–639.

Caplin, A., and J. Leahy, 2001, Psychological expected utility theory and anticipatory feelings, The Quarterly Journal of Economics 116, 55–79.

Caplin, Andrew, and Mark Dean, 2008, Dopamine, reward prediction error, and economics, Quarterly Journal of Economics 663:701.

Charness, Gary, and Dan Levin, 2005, When optimal choices feel wrong: A laboratory study of Bayesian updating, complexity, and affect, American Economic Review 95, 1300–1309.

Chua, P., M. Krams, I. Toni, R. Passingham, and R. Dolan, 1999, A functional anatomy of anticipatory anxiety, NeuroImage 9.

Daw, Nathaniel D., Sham Kakade, and Peter Dayan, 2002, Opponent interactions between serotonin and dopamine, Neural Networks 15, 603–616.

Delgado, M.R., L.E. Nystrom, C. Fissell, D.C. Noll, and J.A. Fiez, 2000, Tracking the hemodynamic responses to reward and punishment in the striatum, Journal of Neurophysiology 84, 3072–3077.

Elster, J., 1998, Emotions and economic theory, Journal of Economic Literature 36, 47–74.

Gervais, Simon, J.B. Heaton, and Terrance Odean, 2005, Overconfidence, investment policy and managerial welfare, Working paper.

Gervais, Simon, and Terrance Odean, 2001, Learning to be overconfident, Review of Financial Studies 14, 1–27.

Gneezy, Uri, and Jan Potters, 1997, An experiment on risk taking and evaluation periods, The Quarterly Journal of Economics 112, 631–645.

Grinblatt, Mark, and Matti Keloharju, 2006, Sensation seeking, overconfidence and trading activity, NBER working paper.

Heaton, J. B., 2002, Managerial optimism and corporate finance, Financial Management 33–45.

Hirshleifer, David, and Tyler Shumway, 2003, Good day sunshine: Stock returns and the weather, Journal of Finance 58.

Kluger, Avraham N., and Angelo DeNisi, 1996, The effects of feedback interventions on performance: A historical review, a meta-analysis, and a preliminary feedback intervention theory, Psychological Bulletin 119, 254–284.

Knutson, B., C. M. Adams, G.W. Fong, and D. Hommer, 2001, Anticipation of increasing monetary reward selectively recruits nucleus accumbens, Journal of Neuroscience 21.

Knutson, Brian, Elliott Wimmer, Camelia M. Kuhnen, and Piotr Winkielman, 2008, Nucleus accumbens activation mediates reward cues’ influence on financial risk-taking, NeuroReport 19, 509–513.

Kuhnen, Camelia M., and Brian Knutson, 2005, The neural basis of financial risk taking, Neuron 47, 763–770.

Lo, Andrew W., and Dmitry V. Repin, 2002, The psychophysiology of real-time financial risk processing, Journal of Cognitive Neuroscience 14, 323–339.

Loewenstein, G., E.U. Weber, and C.K. Hsee, 2001, Risk as feelings, Psychological Bulletin 267–86.

Malmendier, Ulrike, and Geoffrey Tate, 2005, CEO overconfidence and corporate investment, Journal of Finance 60, 2661–2700.

Martinez, D., M. Slifstein, A. Broft, O. Malawi, D. R. Hwang, Y. Huang, T. Cooper, L. Kegeles, E. Zarahn, and A. Abi-Dargham, 2003, Imaging human mesolimbic dopamine transmission with positron emission tomography. Part II: Amphetamine-induced dopamine release in the functional subdivisions of the striatum, Journal of Cerebral Blood Flow and Metabolism 28, 285–300.

Mynatt, C.R., M.E. Doherty, and R.D. Tweney, 1977, Confirmation bias in a simulated research environment: An experimental study of scientific inference, The Quarterly Journal of Experimental Psychology 29, 85–95.

Paulus, M. P., C. Rogalsky, and A. Simmons, 2003, Increased activation in the right insula during risk-taking decision making is related to harm avoidance and neuroticism, NeuroImage 19, 1439–1448.

Pessiglione, Mathias, Ben Seymour, Guillaume Flandin, Raymond J. Dolan, and Chris D. Frith, 2006, Dopamine-dependent prediction errors underpin reward-seeking behavior in humans, Nature 442, 1042–1045.

Phillips, L., and W. Edwards, 1966, Conservatism in a simple probability inference task, Journal of Experimental Psychology 72, 346–354.

Preuschoff, Kerstin, Peter Bossaerts, and Steven R. Quartz, 2006, Neural differentiation of expected reward and risk in human subcortical structures, Neuron 51, 381–390.

Preuschoff, Kerstin, Steven R. Quartz, and Peter Bossaerts, 2008, Human insula activation reflects risk prediction errors as well as risk, Journal of Neuroscience 28, 2745–2752.

Saunders, Edward M. Jr, 1993, Stock prices andWall Street weather, American Economic Review 83, 1337–1345.

Schultz, Wolfram, 2007, Behavioral dopamine signals, TRENDS in Neuroscience 30.

Seymour, Ben, John P. O’Doherty, Peter Dayan, Martin Koltzenburg, Anthony K. Jones, Raymond J. Dolan, Karl J. Friston, and Richard S. Frackowiak, 2004, Temporal dif- ference models describe higher order learning in humans, Nature 429.

Simmons, A., S. C. Matthews, M. B. Stein, and M. P. Paulus, 2004, Anticipation of emotionally aversive visual stimuli activates right insula, NeuroReport 15, 2261–2265.