Bubble brains: Scientists plot biological responses that broke the economy

UK researcher leads study into distorted judgements in financial markets

Five years since the financial crisis, we have had ample occasion to ask the question: what were the people on the trading floors of global finance thinking?

Now scientists think they may have the answer: the decisions and behaviour that lead to market bubbles and financial crashes may have their origins in instinctive biological mechanisms in the brain.

In the first study of its kind, researchers at the California Institute of Technology (Caltech) teamed experts in finance with neuroscientists to investigate whether the brain's activity during the trading process might lead to apparently irrational investments.

Working with a team of volunteer students on an experimental trading floor and using functional Magnetic Resonance Imaging, which can detect changes in blood flow in the brain, researchers observed that the creation of market bubbles was closely associated with heightened activity in two parts of the brain.

People who had greater activity in the area of the brain that processes value judgements were more likely to ride the bubble and lose money by paying more for an asset than its fundamental worth.

Intriguingly, greater activity was also observed in the part of the brain that interprets social signals to predict the behaviour of others. Scientists suggested that this instinctive mechanism - a useful evolutionary tool that enables human sociability - could actually lead to distorted judgements when applied to a "complex modern system, like financial markets". 

Dr Benedetto De Martino, a researcher at Royal Holloway University of London who led the study while at Caltech, said: "They start trying to imagine how the other traders will behave and this leads them to modify their judgment of how valuable the asset is."

The team found that when participants noticed disparity between how much they perceived an asset to be worth and the rate of transactions for that asset, they began making poor business decisions and bubbles started to form in the market.

"They become less driven by explicit information, like actual prices, and more focused on how they imagine the market will change," Dr De Martino said. "These brain processes have evolved to help us get along better in social situations and are usually advantageous. But we've shown that when we use them within a complex modern system, like financial markets, they can result in unproductive behaviours that drive a cycle of boom and bust."

Although bubbles have been thoroughly investigated in economics, the reasons why they arise and crash are not well understood and little is known about the biology of financial decision behaviour, although the phenomenon of "herd mentality" in financial markets has been observed before.

"It's group illusion," said Professor Peter Bossaerts from the University of Utah, a co-author of the study. "When participants see inconsistency in the rate of transactions, they think that there are people who know better operating in the marketplace and they make a game out of it. In reality, however, there is nothing to be gained because nobody knows better."

The study, part-funded by the Wellcome Trust, is published today in the journal Neuron. Although the findings may not help to predict the onset of a bubble, the authors said the research could help to design better social and financial interventions to avoid the formation of future bubbles in financial markets.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs General

Ashdown Group: Trainee Consultant - Surrey / South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Ashdown Group: Trainee Consultant - Surrey/ South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Ashdown Group: Recruitment Consultant / Account Manager - Surrey / SW London

£40000 per annum + realistic targets: Ashdown Group: A thriving recruitment co...

Ashdown Group: Helpdesk / Trainee Application Support Analyst - Hampshire

£25000 per annum + pension, 25 days holiday: Ashdown Group: A highly reputable...

Day In a Page

No postcode? No vote

Floating voters

How living on a houseboat meant I didn't officially 'exist'
Louis Theroux's affable Englishman routine begins to wear thin

By Reason of Insanity

Louis Theroux's affable Englishman routine begins to wear thin
Power dressing is back – but no shoulderpads!

Power dressing is back

But banish all thoughts of Eighties shoulderpads
Spanish stone-age cave paintings 'under threat' after being re-opened to the public

Spanish stone-age cave paintings in Altamira 'under threat'

Caves were re-opened to the public
'I was the bookies’ favourite to be first to leave the Cabinet'

Vince Cable interview

'I was the bookies’ favourite to be first to leave the Cabinet'
Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat
Saudi Arabia's airstrikes in Yemen are fuelling the Gulf's fire

Saudi airstrikes are fuelling the Gulf's fire

Arab intervention in Yemen risks entrenching Sunni-Shia divide and handing a victory to Isis, says Patrick Cockburn
Zayn Malik's departure from One Direction shows the perils of fame in the age of social media

The only direction Zayn could go

We wince at the anguish of One Direction's fans, but Malik's departure shows the perils of fame in the age of social media
Young Magician of the Year 2015: Meet the schoolgirl from Newcastle who has her heart set on being the competition's first female winner

Spells like teen spirit

A 16-year-old from Newcastle has set her heart on being the first female to win Young Magician of the Year. Jonathan Owen meets her
Jonathan Anderson: If fashion is a cycle, this young man knows just how to ride it

If fashion is a cycle, this young man knows just how to ride it

British designer Jonathan Anderson is putting his stamp on venerable house Loewe
Number plates scheme could provide a licence to offend in the land of the free

Licence to offend in the land of the free

Cash-strapped states have hit on a way of making money out of drivers that may be in collision with the First Amendment, says Rupert Cornwell
From farm to fork: Meet the Cornish fishermen, vegetable-growers and butchers causing a stir in London's top restaurants

From farm to fork in Cornwall

One man is bringing together Cornwall's most accomplished growers, fishermen and butchers with London's best chefs to put the finest, freshest produce on the plates of some of the country’s best restaurants
Robert Parker interview: The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes

Robert Parker interview

The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes
Don't believe the stereotype - or should you?

Don't believe the stereotype - or should you?

We exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor