Economics and Neuroscience

Almost every business decision is based on weighing up opportunities and risks. However, our brains tend to organise sensory impressions and information as simply and clearly as possible. We try to concentrate our perceptions on what is most important – all with the aim of economic information processing.

Particularly in dangerous situations, this makes sense. Here it would be absurd to first carry out a complex stochastic scenario analysis to arrive at a result. In this context, the Nobel Prize winner and psychologist Daniel Kahneman talks about two thinking systems that control people – intuitive and rational, and the intuitive is far more powerful than the rational.

The fast and intuitive System 1 instantly recognises patterns based on stored experience and knowledge and responds with ad-hoc actions.  It works fully automatically and without deliberate control. This is very important in emergency situations, for example. Neither a stone age human suddenly faced with a sabre-toothed tiger nor a firefighter who has to react quickly in a crisis situation has time to carry out a structured and complex scenario analysis. Without System 1, which brings about decisions quickly, unconsciously and normally controlled by emotions, we as humans could not survive.

Complementing psychology, neuroscience deals with the functioning of the brain in the broadest sense. Cognitive neuroscience is most important for understanding human decision making. These days, various disciplines from the worlds of biology, medicine, psychology and other related areas such as economics are working closely together.

According to neuroscientist Bernd Weber a few years ago in an interview on the RiskNET competence portal, when we have to deal with complex and risky decisions, it is essential to use appropriate analytical and quantitative risk models. For complex decisions, we should not rely on heuristics or intuition. Intuition is based on the capability to identify patterns in the brain, in other words automatic consideration of "learned probabilities". We spoke to Prof. Bernd Weber (Centre for Economics and Neuroscience, University of Bonn) again about ways to achieve intelligent risk management using findings from neuroscience.

To help our readers understand, what exactly is the task and field of research of neuro-economists?

Bernd Weber: Neuro-economics is at the interface between psychology, behavioural economics and brain research and studies human decision-making behaviour.

It uses methods from neuroscience to investigate the biological principles and influences behind human behaviour.

In a RiskNET interview, you were recently quoted as saying: We can show that collecting psychological and neuroscientific data helps us to understand everyday behaviours better. Can you explain that?

Bernd Weber: Of course. People are very different from one another in their behaviour and their preferences. Some people are more willing to take risks while others are more risk averse. By using personality surveys and behavioural experiments in the lab, we can make predictions about how people tend to behave in their everyday lives.

We recently demonstrated that recording brain activity patterns helps to improve these predictions of behaviour in other situations.

What research are you currently working on?

Bernd Weber: We are currently working mainly on gaining a better understanding of human heterogeneity. What methods can we use to reliably record differences in people’s attitudes and improve our ability to predict behaviour outside the lab? Specifically, we are currently looking at investment behaviour – how do share investors differ from those who tend to avoid this form of investment. What role do financial education and cognitive attitudes play alongside more emotional aspects.

If we apply your academic discipline of neuro-economics to the financial services environment, which methods can be used to answer complex financial questions?

Bernd Weber: Neuro-economics helps to understand individual decision-making better. It can only be indirectly applied to macroeconomic questions by better recording and predicting people’s heterogeneity. Interesting examples here include sunk cost effects or nominal illusions.

In addition to income and education, risk optimism and risk tolerance play a key role when buying shares. Can you explain that in more detail, and how can all this be measured in practice?

Bernd Weber: That’s right. The crucial factor here is how you approach risks. How do you rate the probabilities and how much are you able and willing to tolerate uncertainty. These attitudes can be ascertained using questionnaires and, where necessary, additional behavioural experiments.

Let's leave the ivory tower and turn to the practical applicability of your work. What specific added value can risk managers derive from your academic findings for their day-to-day work?

Bernd Weber: A key issue is that you always have to make two things clear: 1. People are different, they respond differently in situations and are not always predictable. 2. Emotionality plays a major role in human behaviour and we are not always aware of that ourselves.

Therefore, it is important to think clearly about your behaviour in certain situations, where possible in a calm emotional state, and consider what would be the optimum behaviour – in a stress situation we are less capable of doing this and may not even be aware of it.

It appears that the field of neuroscientific research and its results are still being underemployed in strategic considerations in the financial sector. Do you agree?

Bernd Weber: I think there's a two-way split. On the one hand there is a lot of discussion – and this is a huge advance – about the fact that people are biological creatures who use a biological system (the brain) to make decisions.

It follows that they are subject to biological influences and constraints. Making yourself aware of this is a major step forward.

On the other hand, there are plenty of assertions and approaches that appear to be based on neuroscience but have little to do with the actual research. So a certain amount of scepticism in the financial sector about exaggerated claims is definitely justified and actually advisable.

Looking ahead, what research work will you be involved with in the medium term and how can the financial world benefit from it in the future?

Bernd Weber: I can see two major fields that we will be addressing in the future. The first is to establish standardised and reproducible batteries of tests to reliably ascertain individual attitudes. There are major international efforts in this area at present.

Another issue will then certainly be – and this will require considerable interdisciplinary efforts -–applying the findings to meaningful applications in the financial world. I think there is great potential here, but it can only be utilised at the interface between research and users.