Very interesting!! H/T Rob Wile of BI for the find
Investment magnate Warren Buffett has famously suggested that investors should try to “be fearful when others are greedy and be greedy only when others are fearful.”
Many value investors have given up on their strategy over the last 15 years amid concerns that value investing no longer worked. However, some made small adjustments to their strategy but remained value investors to the core. Now all of the value investors who held fast to their investment philosophy are being rewarded as value Read More
That turns out to be excellent advice, according to the results of a new study by researchers at Caltech and Virginia Tech that looked at the brain activity and behavior of people trading in experimental markets where price bubbles formed. In such markets, where price far outpaces actual value, it appears that wise traders receive an early warning signal from their brains—a warning that makes them feel uncomfortable and urges them to sell, sell, sell.
“Seeing what’s going on in people’s brains when they are trading suggests that Buffet was right on target,” says Colin Camerer, the Robert Kirby Professor of Behavioral Economics at Caltech.
That is because in their experimental markets, Camerer and his colleagues found two distinct types of activity in the brains of participants—one that made a small fraction of participants nervous and prompted them to sell their experimental shares even as prices were on the rise, and another that was much more common and made traders behave in a greedy way, buying aggressively during the bubble and even after the peak. The lucky few who received the early warning signal got out of the market early, ultimately causing the bubble to burst, and earned the most money. The others displayed what former Federal Reserve chairman Alan Greenspan called “irrational exuberance” and lost their proverbial shirts.
A paper about the experiment and the team’s findings appears this week in the journal Proceedings of the National Academy of Sciences. Alec Smith, the lead author on the paper, is a visiting associate at Caltech. Additional coauthors are from the Virginia Tech Carilion Research Institute.
Additional coauthors on the paper, “Irrational exuberance and neural warning signals during endogenous experimental market bubbles,” include Terry Lohrenz and Justin King of Virginia Tech Carilion Research Institute in Roanoke, Virginia.
– See more at: https://www.caltech.edu/#sthash.FsmMYtbe.dpuf
More from the study below http://inside.econ.ubc.ca/webfm_send/747
Asset price bubbles are an important example of human group decision making gone awry, but the behavioral and neural underpinnings of bubble dynamics remain mysterious. In multisubject markets determined by 11–23 subjects, with 2–3 subjects simultaneously scanned using functional MRI, we show how behavior and brain activity interact during bubbles. Nucleus accumbens (NAcc) activity tracks the price bubble and predicts future price changes. Traders who buy more aggressively based on NAcc signals earn less. High-earning traders have early warning signals in the anterior insular cortex before prices reach a peak, and sell coincidently with that signal, precipitating the crash. These experiments could help understand other cases in which human groups badly miscompute the value of actions or events.
Groups of humans routinely misassign value to complex future events, especially in settings involving the exchange of resources. If properly structured, experimental markets can act as excellent probes of human group-level valuation mechanisms during pathological overvaluations—price bubbles. The connection between the behavioral and neural underpinnings of such phenomena has been absent, in part due to a lack of enabling technology. We used a multisubject functional MRI paradigm to measure neural activity in human subjects participating in experimental asset markets in which endogenous price bubbles formed and crashed. Although many ideas exist about how and why such bubbles may form and how to identify them, our experiment provided a window on the connection between neural responses and behavioral acts (buying and selling) that created the bubbles. We show that aggregate neural activity in the nucleus accumbens (NAcc) tracks the price bubble and that NAcc activity aggregated within a market predicts future price changes and crashes. Furthermore, the lowest-earning subjects express a stronger tendency to buy as a function of measured NAcc activity. Conversely, we report a signal in the anterior insular cortex in the highest earners that precedes the impending price peak, is associated with a higher propensity to sell in high earners, and that may represent a neural early warning signal in these subjects. Such markets could be a model system to understand neural and behavior mechanisms in other settings where emergent group-level activity exhibits mistaken belief or valuation.
Full study here