Behavioral Finance for Private Banking, 2nd Edition

CHAPTER 4Neurological Foundations and Biases' Moderation

In Chapter 3, we saw that financial decision behavior has a cultural dimension. Now, we want to find out whether some drivers are easier to moderate than others. The insights from neurofinance could help us develop concepts for avoiding investment mistakes, as we will show in the next chapter.

Neurofinance is based on findings from brain research. In recent years, this knowledge has been available due to major technological advances, and is now ready to be applied in finance.

When the human brain began its complex development, simple neural networks were created. From there on, our brain continued to develop over millions of years. Our ancestors spent most of their time fighting for survival—foraging for food, reproducing, and avoiding natural enemies. Only about 3000 years ago we began using our brain for financial decisions as well. Therefore, it is not surprising that investors (professionals and amateur investors alike) systematically deviate from rational decision‐making behavior.

4.1 THE HUMAN BRAIN

To understand neurofinance and its reasoning, we must first take a brief look at the neurosciences. The human brain consists of different parts, as illustrated in Figure 4.08. The oldest part, the inner core of the brain, is the stem. The brain stem controls key bodily functions such as circulation, respiration, and digestion. The next part that developed was the limbic system, responsible for our senses (in the ...