participants who had a brain lesion that eliminated theirability to emotionally “feel” were compared against “normals” in an invest-ment game. The chief researcher, Professor Baba Shiv (now at StanfordUniversity), used a mixed sample of patients with damage in emotional cen-ters including either the orbitofrontal cortex, the amygdala, or the insula.In Shiv’s experiment, each participant was given $20 to start. Partici-pants were told that they would be making 20 rounds of investment deci-sions. In each round, they could decide to “invest” or “not invest.” If theychose not to invest, then they kept their $1 dollar and proceeded to thenext round. If they chose to invest, then the experimenter would ﬁrst takethe dollar bill from their hand and then ﬂip a coin in plain view. If the coinlanded heads, then the subject lost the dollar, but if it were tails, then $2.50was awarded. On each round, participants had to decide ﬁrst whether toinvest. The expected gain of each $1 “investment” was $1.25 (average of $0and +$2.50), while each “not invest” decision led to a guaranteed $1. Theexpected value of the gamble being higher ($1.25), it was always the mostrational choice. Thus, one might assume that subjects always “invested” inorder to make more money.
In fact, the results are not uniform. Normals (without brain damage) in-vested in 57.6 percent of the total rounds, while brain-damaged subjects in-vested 83.7 percent of the time. Many normal subjects (42.4 percent) were“irrationally” avoiding the investment option. Following an investment lossin the prior round, 40.7 percent of the normals and 85.2 percent of thepatients invested in the subsequent round (see Figure 2.5). After recentlosses, normals invested 27 percent less often. They became even more“irrationally risk avoidant” after a loss.
Of the patients with different brain lesions, the insula-lesion patientsshowed the least sensitivity to risk, investing in 91.3 percent of all therounds and in 96.8 percent of the rounds following a loss. As a result, it ap-pears that the insula is one of the most important drivers of risk aversion.Without an insula, brain-damaged patients were more likely to “invest.”
On the lighter side, neurologist Antoine Bechara ventured thatinvestors must be like “functional psychopaths” to avoid emotionalinﬂuences in the markets. These individuals are either much better atcontrolling their emotions or perhaps don’t experience emotions with thesame intensity as others. According to Professor Shiv, many CEOs and toplawyers might also share this trait: “Being less emotional can help you incertain situations.”19
Now you still might be wondering, “Is there a brain area that sabotagesmy investing?” The answer is not clear. It turns out that the lesion patientscan have pretty miserable ﬁnancial lives—accumulating credit card debt,not showing up to work on time, falling for Internet scams, and ultimatelydeclaring bankruptcy. Even though they score normally on IQ tests, there
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i
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FIGURE 2.5 Investment choices of brain-damaged and normal subjects in Shiv’sexperimental task, on average, and following a loss.
is clearly something wrong with their judgment about ﬁnancial risks. Theycan’t seem to recognize the downside of risk or the possibility of catas-trophic loss. So while they make the more “rational” decisions in ProfessorShiv’s tasks, they cannot adequately avoid catastrophic risks in other situ-ations (such as the Iowa Gambling Task).
Most investors avoid ﬁnancial risk after a recent loss, to their ﬁnancialdetriment. Risk avoidance is pretty smart after most types of losses—that’show we learn from mistakes. For example, if the executives of a companyyou are invested in are caught “cooking the books,” leading to a nasty pricedecline, then you might be more wary and do more due diligence beforeinvesting in a similar company. That caution is a good thing, because that’show people learn to avoid unhealthy risk.
In the markets, most investors take away lessons where none exist.They learned to avoid technology stocks after the losses of 2001, eventhough the bear market losses should have had little impact on non-Internet stock performance going forward. After suffering bear marketlosses, most investors wait for price “conﬁrmation” before jumping backinto stocks. They may even sit out the market until new highs are reached.Of course, waiting for conﬁrmation means missing much of the price move,but that’s the price many people are willing to pay for enhanced conﬁdence.So far you’ve seen how researchers used a card game (Iowa Gam-bling Task) and a coin-ﬂipping gamble (Shiv’s task) to assess ﬁnancialdecision-making behavior in brain-damaged people. Many other techniqueshave been used in decision-making research. As you’ll see below, the
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technologies available to researchers have exploded in complexity overthe past decade.
RESEARCH METHODS
There are many levels of function in the brain, from the actions of indi-vidual molecules to broad communications between lobes. At a molecularlevel, neural activity is driven by neurochemicals, small electrical currents,and genetic transcription. On the anatomical level, there are neural circuitsthat cross brain regions and give rise to complex thoughts and behav-iors. These are building blocks of a neurological understanding of thebrain.
Researchers utilize a variety of sophisticated tools to understand howthe brain works. Neuroimaging is the most widely used technology for un-derstanding decision making. Most of the neuroimaging studies cited inthis book use functional magnetic resonance imaging (fMRI). fMRI allowsresearchers to visualize changes in oxygenated blood ﬂow, which servesas a proxy for brain metabolism. fMRI can yield resolution of brain vox-els as small as 2 × 2 × 2 millimeters over time intervals of two seconds.Positron emission tomography (PET), which is an alternative neuroimag-ing technique to fMRI, has a larger spatial resolution of approximately 3 ×3 × 3 millimeters and can detect changes in glucose metabolism and bloodﬂow only when a radioactive tracer has been injected into the subject.
Other investigative technologies include behavioral measures, subjec-tive reports, psychological tests, and electrophysiology. Electrophysiologyinvolves measurements of heart rate, blood pressure, galvanic skinresponse (sweating), and other physical variables, many of which areindicators of reactive brain activation in limbic and midbrain regions.Pupillary eye measurements allow researchers to directly monitor theactivity of the SNS. As previously mentioned, the SNS is involved in the“ﬁght-or-ﬂight” response.
Electromyograghs (EMGs) measure electrical activity during musclecontraction. When EMGs are used on facial muscles, very subtle statesof happiness and concern can be measured. For example, analysts whoare excited about an investment idea have greater activation of theirzygomatic facial muscles when they talk about that investment. Thezygomatic muscles control smiling. The frontalis muscle on the foreheadis activated by concern, revealed in a furrowed brow, and is more activein traders during stressful market volatility.
Historically, many researchers used electroencephalograms (EEGs)for experimentation. An EEG is a test used to detect ﬂuctuations in the
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electrical activity of the surface of the brain’s cortex. EEGs are oftenused clinically to diagnose seizures. Some psychotherapists use EEGs foremotional biofeedback (so called “neurofeedback”). For example, a familytherapist may use EEGs to monitor when the limbic system of one mem-ber of a family is triggered by another. The triggered member is likely torespond automatically and emotionally to provocations. Self-monitoringEEG activations allows the triggered family member to learn to inter-rupt and prevent automatic emotional responses that might be hurtful toanother.
Single-neuron recording techniques are very invasive and are per-formed primarily on monkeys and rats. Such techniques have allowedresearchers to model the activity of tiny neuronal bundles, including thoseused while computing the expected value of various decision options.Genetic sequencing technologies such as the polymerase chain reaction(PCR) have revealed that genes correlate with prominent personalityand behavioral traits. Assays of blood and cerebrospinal ﬂuid allowresearchers to measure hormones (such as those mediating trust andthe stress response) and neurotransmitters (including those involved inimpulsiveness).
A research technique most often used by neurologists is the study ofpatients with speciﬁc brain lesions. Lee is an excellent example of this typeof patient. Small brain lesions secondary to focused strokes or tumors cancause isolated impairments. These impairments can teach us a great dealabout the function of speciﬁc brain regions.
The human brain contains approximately 100 billion neurons with100 trillion connections between them. The neuron count inside our headsis comparable to the number of stars in our galaxy, the Milky Way. With thisextraordinary complexity, it is unlikely that we will ever have a “model” ofwhat it is to be human. No amount of brain research can adequately portraya feeling, a memory, or an experience.
Describing the mind in terms of brain circuits, personality traits, andgenetic inﬂuences is deceptive. Individuals are not pieces thrown togetherinto one predictable whole. Each person is different, unique, and incompre-hensibly complex. They each nurture their own authentic interests, hopes,and aspirations. The human brain is the complex organ that gives rise towho we are, and its mysteries remain largely uncharted.
NEUROSCIENCE PREVIEW
The following is a very quick and general description of many of the brainregions discussed in this book. It is intended as a resource that you can
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refer back to from future chapters. It is quite dense with information, andyou don’t need to internalize this all at once. Feel free to skim ahead to thenext chapter.
The functions of the prefrontal cortex, reward system, and loss systemin ﬁnancial decision making are discussed in this book. Much of optimalﬁnancial psychology lies in the self-awareness and self-control of limbic(emotional) impulses. By exercising “emotional intelligence,” one canmaintain ﬂexibility in the face of opportunity and danger. Emotionalintelligence is derived from the prefrontal cortex and the strength of itsconnections to the limbic system.
The prefrontal cortex has several regions that assist with differentaspects of emotion management. The prefrontal cortex assists withplanning for the future, following rules, directing focus and attention,executive decision making, and exerting self-control. More speciﬁcally,the orbitofrontal cortex (OFC) integrates reason and emotion, while theanterior cingulate cortex (ACC) resolves decision conﬂicts and prioritizesemotional information as either relevant or unimportant.
The limbic system has two major divisions of relevance to inves-ting—the reward pursuit and loss avoidance circuits. Reward pursuit in-volves everything from how people value various prospects to how posi-tive and motivated they feel toward obtaining desired goals, to their searchfor novelty. The loss avoidance system underlies fear and hesitation anddrives the avoidance of perceived threats.
The reward system is the origin of several important ﬁnancial bi-ases. Increased reward system activation can generate optimism, overcon-ﬁdence, and excessive risk-taking. The major regions of relevance in the re-ward system are the nucleus accumbens (NAcc) and the medial prefrontalcortex (MPFC).
The NAcc is the brain’s center of lust and desire. The NAcc is activatedby the anticipation of earning money, and it drives pursuit of the items orinvestments that one wants. High NAcc activation drives excessive ﬁnan-cial risk taking. The MPFC, which is one terminus of the dopamine neuronsof the reward system, is activated by trust and certainty, satisfaction whenrewards are received, learning how to obtain rewards, and learning fromsuccesses and mistakes.
Hypoactivation or desensitization of the reward system results in apropensity to feel apathetic, have low energy, and engage in compensatoryexcitement and novelty-seeking behaviors such as pathological gamblingand compulsive shopping. Short-term gains energize dopamine ﬂow in thereward circuit.
Activation of the brain’s loss system results in stress, anxiety, disgust,pain, and even panic. The behavioral bias of loss aversion is fueled by fearsof disappointment and regret, and arises from amygdala activation. The
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anterior insula is an area of primitive cortex that governs the experiencesof disgust, pain, and loss. Anterior insula activation precedes excessive riskaversion in one investment experiment. The physical and mental effectsof stress are generated by hormonal and chemical pathways in the losssystem.
The next chapter will discuss the links between brain and mind. In par-ticular, the mental origins of emotions, expectations, beliefs, and self-deception are described.
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C H A P T E R 3
Origins of MindExpectations, Beliefs,and Meaning
“What gets us into trouble is not what we don’tknow. It’s what we know for sure that just ain’t so.”—Mark Twain
I did some of my psychiatry training at the San Mateo Medical Center
psychiatric emergency room (ER). In the ER we provided urgent men-tal health services for the northern part of Silicon Valley. I had theprivilege of working with interesting and diverse clients in crisis, includingengineers, venture capitalists, and executives.
Doug was wheeled into the ER on a gurney one evening in August 2001.He had been working late, and he was found by a security guard slouchedover his desk, crying uncontrollably. He told the ofﬁcer he felt like dying,so the ofﬁcer called 911.
During my evaluation of him in the ER, he told me the following story:In 1999, while working as an accountant for Oracle, he became a papermillionaire. His Oracle stock options had rocketed in value. For him, thiswasn’t a big deal; it seemed like everyone he knew at the time was worthmore than $1 million.
He bought two nice cars and a large home. More importantly, he feltlike a somebody, “like I had ﬁnally arrived.” He was in the center of actionat an unparalleled time in world business history. He was young (30 yearsold), ﬁnancially secure, valued at his workplace, and enjoyed life. Thoughhe was born, raised, and educated in the U.S. Midwest, there was an instantintimacy and rapport among the in-crowd in the Valley.
As the stock market began to slide in late 2000 and early 2001, and hisoptions’ value declined, he tried not to pay attention. “It’ll come back,” he
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told himself, “we’re changing the world.” By mid-2001 he grew concerned,and he decided to check what his options were currently worth. He wasshocked by what he discovered. He told me, “Doc, the options were a tenthof what they had been. They had been worth $2.6 million, and now I was al-most broke!” For two weeks he felt vacant and in utter despair. At work hechecked Oracle’s stock price often, refreshing his Web browser every fewminutes to get the latest quotes. He felt buoyed by up days, but increasinglydepressed by the more frequent down days. Within weeks his options weretrading under water, worth nothing.
Doug was obsessed with his sudden loss in wealth and the continu-ing slide in Oracle’s share price. Over and over he asked himself, “Howcould this happen?” He couldn’t sleep at night. He lost his appetite. Dougsaid that out of the blue he began to feel intense periods of dread atwork. He didn’t want to go in anymore. No matter how hard he tried tostay positive, he began to have unexpected and unwelcome thoughts ofsuicide.
He was so overwhelmed by options losses that he was consideringsuicide. Yet his losses had all been on paper. Nothing substantial hadchanged in his life when he lost that paper wealth. His actual salary re-mained the same. He could still easily afford his house and car payments,and he remarked that his net worth was positive.
So if nothing “real” had changed in Doug’s life, why was he feelingsuicidal? I asked him this question, and he earnestly responded, “BecauseI can’t retire now.”
I asked, “Retire now, at 30?”“Yeah, now I’ve got to work the rest of my life. Who am I without that
money? I was a millionaire, and now I’m just another guy.”
Doug’s identity was tied up in his money, and now he had lost it. Afuture that had seemed wide open with possibility now appeared dreary,lonely, meaningless, and dull. He had few real friends or outside interestsin California. He had no other way to measure his worth other than hisﬁnancial status. And his wealth, which he had thought was a reﬂection ofhis goodness as a person, was erased. So here he was, a complete failurein terms of his value system, now paralyzed by fear that he could neverrecover what he once had. He saw no reason to go on living.
We discussed how his wealth and the culture of Silicon Valley had al-tered his values. We talked about meaningful connections from his child-hood and college years, and his belief in a universe that is greater thanhimself. He talked excitedly about the passion for numbers that had drivenhim to study accounting in the ﬁrst place.
When Doug’s visit to the psychiatric emergency room was concluded,and I was walking him to the exit with a sheaf of papers listing our
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treatment recommendations, he turned to me with a smirk and said, “TheCFO told me we’re going to beat our numbers next week, so maybe I’ll beall right after all.”
Doug hadn’t needed the millions he had accumulated in stock options.But having that money in the bank changed how he saw himself. Whenit was gone, the conﬂict between his previous “Internet millionaire” sta-tus and his new self-identity as “an accountant in a dead-end job” wasoverwhelming. Yet nothing had fundamentally changed for Doug. All thewealth he had “lost” was on paper. The only tangible change was one ofperception.
EMOTIONS AND PERCEPTIONS
How each person deals with changes in wealth depends on how theycreate personal meaning out of losses and gains. Whether a personis overwhelmed or resilient is more contingent on his beliefs and ex-pectations than on his physical reality. One’s life conditioning, innatepersonality traits, recent events, culture, and environment all inﬂuencehow events are interpreted. And it is a person’s interpretations of eventsthat give rise to strong emotions, such as the depression that afﬂictedDoug.
Because emotions underlie so much of thought, behavior, and per-ception, and they are largely unconscious, they are discussed in detail inthis book. Emotions are subjective feelings that serve as easy shortcuts(or heuristics) for the brain. In particular, emotions tell us how one isdoing related to speciﬁc goals and threats. On the one hand, the emotionof excitement indicates that one has identiﬁed an opportunity. Excitementpropels increased risk seeking and exploratory behavior. On the otherhand, the emotion of fear notiﬁes one of potential danger. Fear gives riseto behaviors of risk aversion and withdrawal.
Simplistically speaking, emotions are like a trafﬁc light for the brain.When considering an opportunity or threat, emotions indicate whetherone should go forward with risk-taking (excitement), proceed with caution(concern), or stop and withdraw (fear). Such emotions are anticipatory.They help people broadly prepare for threats or opportunities, and they arefundamental to the coordination of thought and action away from danger(loss avoidance) or towards opportunity (reward seeking).
When a threat becomes reality, resulting in immediate danger, thenone may make a panicked effort to ﬂee (ﬂight), freeze in terror, or becomecombative (ﬁght), giving rise to the colloquial expression “the ﬁght or ﬂight
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response.” This response is a reaction to danger. If one is anticipatingdanger, fear is experienced, but if one is reacting to danger, then the“ﬁght-or-ﬂight” response is provoked.
This distinction between anticipatory and reactive emotions is impor-tant. Amateur investors often buy stocks based on their expectation of aprice change in their favor. Anticipatory positive emotions are likely to biasthis investor’s expectations and inappropriately diminish their risk percep-tions. Investors often sell stocks in reaction to events, whether a biggerthan expected proﬁt or a piece of unexpected negative news. Such reactiveselling is typically not in response to a rational plan, but rather emotionallydriven.
Emotions inﬂuence thoughts and perceptions, driving pessimistic oroptimistic thinking styles. As an example of emotions biasing cognition,recall that Doug’s powerful experience of ﬁnancial disappointment drovehim to have unwanted thoughts of suicide. As a further example, amongmany investors fear leads to knee-jerk expectations of an impending re-cession or price decline, and it often drives premature selling of riskyholdings. Yet if you ask a fearful investor why they are selling, theyusually won’t say, “Because I’m afraid”; rather, they might cite nega-tive economic events. Emotional investors are unaware that it is notfacts that are driving their outlook, but perceptual distortions caused byfeelings.
Affect is a word that broadly refers to emotional experience. Feelings,moods, and attitudes are all affects. Shortcuts in the thinking process dueto feelings are functions of “the affect heuristic.” A heuristic is a type ofmental “short-cut,” where rather than objectively reasoning through a de-cision, individuals choose based on a “hunch.” The term affect heuristicwas coined by Professor Paul Slovic.
Emotionally, the affect heuristic refers to the feeling “tags” that peo-ple place on complex judgments. For example, when asked about Googleand IBM, an investor may feel (and subsequently think): “Google is goodand exciting” or “IBM is old and boring.” Their thoughts arise from internalemotional tags that are attached to each concept. These tags serve as sim-ple and rapidly accessible judgments. The affect heuristic allows for quickdecision-making under conditions of time-pressure and uncertainty. Theaffect heuristic refers to chronic, low-intensity emotional tags.
Strong anticipatory and reactive emotions alter judgment and guidedecision making through a brain system that generates and monitors goalpursuit. A diffuse brain system called the comparator assesses whetherone is making expected progress toward one’s goals. When expectationsof goal progress are exceeded, happiness arises. When expectations arenot met, disappointment occurs. The comparator underlies most humanmotivation and behavior.
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EXPECTATIONS AND THE COMPARATOR
The brain’s comparator assesses one’s actual goal progress against one’sexpected progress. When self-monitoring, it is where one stands relativeto expectations that determines which emotions arise and how one willconsider a strategy for closing the gap going forward. The comparator is afeedback system that maintains motivation.
The intensity of the feelings that arise in response to comparisonsdiffer based on three characteristics: (1) the size of the discrepancybetween expectations and reality, (2) one’s conditioning (experience) withsimilar situations, and (3) any signiﬁcant associations or memories. A littlediscrepancy between expectations and reality produces a small signal,while a larger difference gives rise to a stronger emotion, and thus a morepowerful motivation. The comparator (see Figure 3.1) receives input fromboth the reward system (goal approach) and the loss avoidance system(goal avoidance).
Goal approach refers to the motivational actions of the reward system,driving individuals toward achieving desired and expected goals. Feelingsrelated to elation, such as happiness, joy, euphoria, and contentment aregenerated when goal approach progress exceeds one’s expectations. Whengoal approach is inadequate relative to one’s expectations, feelings relatedto disappointment such as sadness, upset, discomfort, and depressionarise.
Goal Approach
Goal Avoidance
ELATION
RELIEF
DISAPPOINTMENT
ANXIETY
PositiveProgress
NegativeProgress
FIGURE 3.1 The brain’s comparator generates emotional experience based onthe diﬀerence between one’s expectations and actual goal progress.Source: Derived from Carver, C. S., and M. F. Scheier. 2001. “On the Structure ofBehavioral Self-Regulation.” In M. Boekaerts, P. Pintrich, and M. Zeidner (eds.), Hand-book of Self-Regulation. New York: Academic Press, pp. 42–80.
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Goal avoidance refers to the function of the loss system, which moti-vates individuals to avoid or escape dangerous circumstances. When lossavoidance is successful, feelings of relief occur. Feelings of anxiety, worry,concern, and nervousness arise when one is not avoiding dangers as wellas anticipated.
Supporting the model of the comparator, neuroimaging shows thatexpected ﬁnancial rewards activate the reward system less when they arereceived. When goal progress is equal to expectations, then no emotionalreaction occurs.1 However, both unexpected rewards and unexpectednews that one is going to receive a reward are highly activating, becausethey both exceed expectations of goal progress.2
Interestingly, when news of an impending reward is received, butthe expected reward never comes, then the brain will show inhibitedactivity. Speciﬁcally, there is decreased dopaminergic neuronal ﬁring inthe reward circuits at the precise time when the expected reward shouldhave occurred.3 Perhaps this is a neural representation of disappointment.
COUNTERFACTUAL COMPARISONS
Emotions often arise when one compares his or her life circumstances tothose of others. Psychologists set up an experiment in which they clippedout the photos of Olympic medal winners’ faces during the award cere-mony at the Olympic Games. Strangers were then asked to rate the levelof positive or negative emotion on the faces of the medal winners, withoutknowing which medal they had won. The researchers found that, as ex-pected, gold medal winners expressed the highest level of positive feeling.Surprisingly, bronze medal winners had the second-highest level of positiveemotion, while silver medalists came in third.4 Why are silver medalists lesshappy than bronze medalists?
The Olympians were experiencing counterfactual comparisons.Bronze medalists make a downward comparison, due to a “cutoff effect,”and they felt happy that they had earned a place on the winners’ podium.Silver medalists made an upward comparison, and they felt slightly disap-pointed by what they saw—someone who performed better.
Counterfactual comparisons also affect how people feel about prof-its and losses. Professor Barbara Mellers at the University of California atBerkeley designed a gambling experiment to assess emotional reactions tolosses (gains) if a larger loss (gain) had been avoided. Subjects were askedto play a 50–50 gamble. In one version, subjects would either win $8 or win$32 (each with 50 percent probability). In another gamble, subjects wouldeither lose $8 or lose $32 dollars, again with 50 percent probability. The
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subjects had no choices to make, but they were asked to rate their feelingsafter seeing the results of the gamble.
Subjects reported feeling slightly positive when they lost $8 if they hadavoided losing $32. When the subjects won $8, they reported slight dis-satisfaction because the other outcome was to win $32. The subjects feltgood about losing $8 if the gamble was in the “loss frame,” and they feltbad about winning $8 in the “gain frame.” Their comparison of the actualoutcome to the gamble’s expected value (in this experiment the expectedvalues were $20 in the gain frame and –$20 in the loss frame) determinedhow they felt about the outcome.
This comparison phenomenon occurs throughout the business world,where measures of self-esteem and accomplishment are often made tangi-ble. Silicon Valley billionaires may feel jealous of the size of each others’yachts, leading to a boom in the construction of ultra-luxury vessels