Areas of brain linked to risky, risk-averse financial choices, researchers find

L.A. Cicero Kuhnen, left, and Knutson are co-authors of “The Neural Basis of Financial Risk-Taking.”

A Stanford psychology professor and a doctoral candidate in finance have shown for the first time that activation of two parts of the brain linked to excitement and anxiety influence rational and irrational financial decisions. The findings, the researchers argue, ultimately could be used to improve the design of economic institutions to help investors make better choices.

"If you read academic finance and economic literature, you see that people don't really accept the notion that affect, or emotion, can play a role when you make economic choices," said Camelia Kuhnen, a doctoral candidate at the Graduate School of Business. Kuhnen and psychology Assistant Professor Brian Knutson are co-authors of "The Neural Basis of Financial Risk-Taking," which was published Sept. 1 in Neuron. "We academics tend to assume that people are rational and levelheaded when they make important decisions," Kuhnen added. "But psychologists show that [emotion] matters for a lot of things." In one of the first collaborations between neuroscience and economics, Kuhnen and Knutson carried out the study to find out whether emotion also can affect a person when it comes to making investments.

They discovered that it does.

"People are not as rational as we would like them to be," Kuhnen said. "I'm happy we got these results because I believe this is evidence that economists should take [emotion] into consideration when we write [investing] models for individuals."

Kuhnen and Knutson used functional magnetic resonance imaging (fMRI) to scan volunteers' brains as they performed an exercise that required them to choose between two stocks and a bond that offered real financial gains and losses. (fMRI scans use magnetic fields to map blood flow in brain regions. When an area is active, blood flow increases.)

In the study, the researchers randomly designated one of the stocks a "bad" stock, which was more likely to lose money, and the other a "good" stock, which was more likely to make money. The bond offered a safe but low-return investment.

The 19 study participants, all Stanford doctoral students, were asked to pick between the two stocks and one bond 10 times during 20 separate games. The volunteers did not know which stock was good or bad, but had to figure out which was which by watching the market. Subjects also could select the bond.

During the experiment, held at Stanford's Richard M. Lucas Center for Magnetic Resonance Spectroscopy, the researchers looked at activation of two parts of the brain linked to emotion. The nucleus accumbens (NAcc) is a peanut-sized area that becomes active when someone expects a reward of a primary nature, such as water if a person is thirsty, Kuhnen said. It is an area rich in the molecule dopamine and is linked to the addictive effect of drugs. In past studies, Knutson has shown that the nucleus accumbens also activates if someone anticipates a financial reward, even before he or she actually receives the money.

In contrast, the anterior insula, another part of the brain linked to anxiety, lights up when a person sees disgusting, repulsive stimuli, such as mutilated bodies, or when someone anticipates physical pain, Kuhnen said.

In the study, the researchers discovered that the nucleus accumbens kicked into action two seconds before subjects made a "risk-seeking" choice that was a mistake—when they decided to invest in a stock even if it had a bad history. In contrast, the anterior insula was activated just before the volunteers made a less than optimal "risk-averse" choice that prompted them to invest in a safe but low-return bond instead of the good stock. Overall, the study found that volunteers made the rational, optimal choice 75 percent of the time.

"Basically, [the findings] confirmed our hypothesis that these two areas are involved in decision-making," Kuhnen said. "What was [most] interesting was to look at the activation of these two areas before one makes investment choices. The question is, can you predict whether or not people are going to choose a risky investment or a risk-less investment? Moreover, can you predict whether people will make a mistake when they choose an investment?"

The researchers noted that institutions encouraging either "risk-seeking" behavior—such as casinos—or "risk-averse" behavior—such as insurance companies—understand how excitement and anxiety influence people's decisions. "You go to Vegas, and you are surrounded by all these rewards—free food, potential prizes," Kuhnen said. "We know from past studies that sights of potential rewards can activate your NAcc. What this study shows is that when the NAcc is activated, you tend to be more risk seeking. You tend to choose the stock more often and you tend to choose it when you shouldn't." An insurance company appeals to opposite emotions, Kuhnen added. "If you go to an insurance office, people will show you pictures of crashes or tell you how you could be hurt. We know that such a stimulus might activate your anterior insula. Our study shows that high insula activation is a predictor of you making a risk-averse choice."

According to the researchers, if the emotional states of individuals are included in rational decision-making models, people will be able to make better financial choices. "That's our contribution," Kuhnen said. "This work encompasses the rational model but it gives you a little more. Nobody has ever predicted [financial decisions] using brain activation—you really can't go deeper than that."

The findings can benefit individuals, Kuhnen said, in addition to economic institutions. For example, she explained, if people see a piece of chocolate cake that stimulates their nucleus accumbens, they may be more likely to engage in "risk-seeking" behavior, such as shifting their portfolio into high-risk foreign stocks: "You have to ask yourself, is this my true preference? If I woke up tomorrow, would I make the same choice?" In other words, when making a big decision, take a step back and think before plunging ahead.