How the Brain Is Wired for Finance

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Meet Camelia Kuhnen, neuroeconomist. You may not have heard of her yet, but her work is even more intriguing than her title.

The 31-year-old wunderkind of money and mind is a pioneer in the promising new field of neurofinance – a seemingly odd fusion of economics with neuroscience and psychology.

Kuhnen, who grew up in Romania, has been working in this field since she was an undergraduate at MIT. She earned a PhD in finance from Stanford and became an assistant professor of finance at Northwestern University in 2006.

Her findings aren’t abstract theories that only work in a brain-scanning lab. Her research is providing practical insights for anyone who cares about money and their financial decisions. She has shed light on why some people save for retirement and others don’t, how emotional states can influence economic decisions, and why some people compulsively gamble or take financial risks while others shy toward fiscal conservatism.

Kuhnen’s work has the potential to influence perspectives and policies on financial ethics, risk management, addiction, pay incentives, genetic screenings and more. Medill News Service sat down with Kuhnen to pick her brain about this fascinating field and where it’s headed.

Camelia Kuhnen (Photo courtesy of Daniel Peake/MEDILL)Camelia Kuhnen (Photo courtesy of Daniel Peake/MEDILL)What is neuroeconomics, or should I say neurofinance?
There’s really no difference between neuroeconomics and neurofinance. It’s a field that started maybe seven years ago, and the goal is to put together knowledge from science – psychology, sociology and economics – to understand how people make decisions.

From the point of view of an economist, the field should provide us with a much better understanding of how we choose the things we do. Why do some people take a lot of risks in their finances and other people don’t? Why do some people save very little for retirement and some save a lot more? Why do some people become overconfident when they invest?

How did you become interested in this field?
I was at MIT as an undergrad, and I majored in two things – neuroscience and finance. While I was finishing up at MIT, I worked as a research assistant for a famous professor there in the finance department, Andrew Lo. He was starting to dabble into behavioral finance, sort of the psychology of investing behavior. And that got me interested in thinking, “Can I also mix in neuroscience – literally how the brain works – in finance?”

I moved to Stanford and was doing my PhD in finance, doing very normal finance things. But there was a very interesting person in the psychology department—Brian Knutson. He’s a neuroscientist and one of my most frequent co-authors. Brian was offering a class called Affective Neuroscience, or the neuroscience of emotions. So I took that class and designed an experiment, which Brian and I later completed, to understand whether brain areas we know are linked to emotional states are critical for financial decisions. And it turns out they are.

What’s another example of your neurofinance work?
We knew from prior work, some of it being mine, that areas in the brain that use dopamine and serotonin are important for how much financial risk you take. And so the question was, the genes that regulate these two chemicals, can they also explain how much financial risk people are willing to take?

We looked at two genes, one that regulates dopamine and one that regulates serotonin. We knew from other work that a specific variant of the dopamine gene is particularly prevalent among people who are pathological gamblers. And we knew there was one variant of this serotonin gene that is prevalent among individuals with anxiety problems, which is like an extreme form of being very risk-averse.

We then had people play an investment game for real money. It was a stylized setting for basically how you’d invest in your day-to-day life. How much of your paycheck do you want to put in your bank account, a safe investment, and how much do you want to park in those stocks, a bigger risk? Based on their test, you can infer how risk-averse or risk-seeking people are.

We found exactly what we expected. If you had the variant of the dopamine gene that is prevalent in pathological gamblers, you tended to put more money in the risky asset. If you had the version of the serotonin gene that you see more in those that have anxiety disorders, you tend to put less money in the risky asset and more money in the safe asset.

Which versions of the dopamine and serotonin genes do you have?
I’m not going to say. I know which ones I have, though. I was surprised.

Does all of this really translate to real life?
I’m happy to say that it translates quite well in the real domain, and I’m basing this on some recent work I’ve done for two papers. In both of these papers, we show that there is a clear link between the performance of individuals in our lab experiments – these financial investment tasks – and how well off they are in real life.

So the answer is yes. We can extend what we’ve found to real-life behavior, and there is what we call external validity to these studies.

What’s the future of neurofinance?
I think we still have so much to find out about how people learn in financial markets and how they make decisions. It’s going be a busy five years, at least.

The goal is to get a relatively simple and manageable model of how people behave that’s based on how the brain really operates and that economists can use. Hopefully it will allow us to predict behavior that we just can’t make sense of using the models we’ve had for 50 years that everybody’s rational, nobody makes any mistakes.

So which one is better – neuroscience or finance?
I love this work. I love both the corporate finance work and the neuroeconomics work, I think they’re both very useful for us as people to understand. On one hand, we’re talking about incentives and how we should structure contracts to make people do the right thing, on the other hand we’re talking about how the brain understands information about financial concepts and how we make decisions. I think they’re both very important questions, and I’m excited to work on them. And it’s just fun.

 

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