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“Traders don’t like to be tested”

World renowned researcher and author, American Paul Glimcher explains why neuroeconomics can change the future of finance.

The father of neuroeconomics

Considered one of the pioneers of neuroscience, American Paul Glimcher is the author of several books on the subject. His often award-winning research is based on an interdisciplinary approach that uses neuroscience, economics and psychology to understand how humans make decisions. Director and founder of the Institute for the Interdisciplinary Study of Decision Making at New York University (NYU). He is the author of the seminal book Neuroeconomics: Decision-Making and the Brain, first published in 2008 and then edited and re-released in 2013. It was co-written with Ernst Fehr, professor at the University of Zurich.

The Glimcher Lab at New York University (NYU) brings together the latest developments in neuroscience, economics and psychology. Founder and head of the lab, Paul Glimcher spoke to us over the phone from his New York office.

How is neuroeconomics useful to investors?

This discipline makes it possible for us to better understand the mechanisms involved in decision-making as well as their consequences. Thanks to neuroimaging, it is possible, for example, to predict the degree of a person’s aversion to risk based on the size of its right posterior parietal cortex. Various studies also show that traders are strongly averse to loss and can become easily addicted to risk. Overall, we’re understanding more and more from a biological perspective just how the brain evaluates losses and gains.

But these tests seem to be limited to research only. Are there concrete applications of this work in finance?

Some universities are starting to connect this to the industry. But you’re correct in that the companies which are interested in our work are first those with an interest in neuromarketing. Most banks and trading companies place far more importance in understanding global market phenomena rather than the individual behaviour of traders.

Why is that?

The industry really does not like change. And it’s well known that most traders don’t like to be tested like subjects in science experiments. However, trading companies could benefit from new discoveries in neuroeconomics. In theory, they could define their objectives and desired risk levels for a certain portfolio and then recruit employees based on these criteria. That would make sense. But in reality, banks prefer to hire traders based largely on their past results. That said, a good track record also involves a bit of luck.

Will bank practices in this industry evolve?

In the sense that models based on neuroeconomics will become much simpler to interpret and increasingly reliable, it’s likely that this tool will gain legitimacy in coming years. Neuroeconomics would be particularly useful in optimising the efficiency of day trading. But as machines are becoming very effective in this field, I have a feeling that trading companies are gradually freeing themselves from individuals. It’s ironic in a way: just when neuroeconomics is becoming an advantage for banks, progress in artificial intelligence could make human traders superfluous...

Besides trading, how else can finance benefit from your research?

Neuroeconomics is no longer exclusively limited to studying the behaviour of one individual. It’s just a start – and this approach is still very controversial – but it’s becoming possible to expand the field of study to macroeconomic phenomena. This could help us understand how bubbles are formed, for example. A team from the California Institute of Technology (Caltech), led by Professor Colin Camerer, is experimenting with this type of tool. It is developing macroeconomic models based on individual MRI scans. Another notable evolution is that we’re no longer just talking about understanding the way people make decisions but also how they process and handle new information.

What type of information?

From authorities, for example. A classic example is the market’s surprising reaction when a central bank lowers interest rates. While low interest rates are a clear and reliable signal, consumers often don’t react for several months. They seem to be paralysed. We’re increasingly convinced that this attitude reflects certain biological limits of the attention span and comprehension of the human brain associated with decision-making. Several studies based on neuroeconomics point in that direction.

Financial risk is often the focus of neuroeconomics studies. But there are other types of risks, such as voluntarily risking one’s life... Is that the same biological mechanism?

That’s a fascinating question and very controversial. Some studies seem to indicate that there are different types of risks which are processed by different parts of the brain, and so our attitude towards risk in general isn’t necessarily the same across the board. According to this theory, someone can be very passionate about extreme sports but very risk-averse when it comes to financial investments, or the opposite. This is what Professor Elke Weber from Princeton University thinks. However, other researchers believe that propensity or aversion to risk is pretty similar regardless of the type of risk.

Do you see differences based on gender?

It’s agreed upon that women on average have a significantly higher aversion to risk than men. A lot of studies confirm this. But the reason why hasn’t yet been clearly established. Testosterone doesn’t necessarily play a decisive role. Researchers think that this difference is associated with the way men and women judge their probabilities of success: it seems that women judge their chances more modestly.

 
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