Addicted to risk-taking

It’s easy to dismiss Jérôme Kerviel, the rogue trader at Société Générale, as a fluke. So here...

It’s easy to dismiss Jérôme Kerviel, the rogue trader at Société Générale, as a fluke. So here is a sobering thought for Wall Street: There may be a bit of Kerviel in all of us.

A small group of scientists, including some psychologists, say they are starting to discover what many Wall Street professionals have long suspected—that people are hard-wired for money. The human brain, these researchers say, responds to high-stakes trading just as it does to the lure of sex. And the riskier the trades get, the more the brain craves them.

French prosecutors

have likened Kerviel’s trades to a drug habit. That is no surprise to Brian Knutson, a professor of psychology and neuroscience at Stanford University and a pioneer in neurofinance, an emerging field that combines psychology, neuroscience and economics, to examine how the brain makes decisions.

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Knutson has sent volunteers through high-power imaging machines to map their brains as they trade. He concludes that sometimes, people get high on making money. “The more you think you can gain from the risk, the more you take the risk and the more activation in the circuitry,” Knutson said.

Neuroeconomics has not won many converts on Wall Street. Researchers like Knutson have yet to show how their work can be applied effectively in the markets. And some academics question whether the field is of any use in economics.

“Economics is about equilibrium, and supply and demand, and forces that come to some stabilized system,” says Stephen A. Ross, the Franco Modigliani Professor of Finance and Economics at the Massachusetts Institute of Technology. “It’s not about atoms or how little people behave.”

Even so, the field seems to be gaining some traction. Last year Jason Zweig, who edited the 2003 edition of The Intelligent Investor by Benjamin Graham, wrote a 352-page book entitled Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make Your Rich. One of his findings was that brain images of drug addicts who are about to take another hit are indistinguishable from those of traders who are making money and about to place another trade. “That tells us pretty confidently that if you make money and make money again,” Zweig said, “it is very similar to a chemical addiction and it becomes very hard to let go.”

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Daniel Kahneman, a Nobel Prize-winning psychologist, showed individuals do not always act rationally when faced with uncertainty in decision making. When faced with losses, individuals may seek to take more risk rather than less, contrary to what traditional economic thought might suggest. “When you are threatened with extinction, you act like nothing matters,” said Andrew Lo, a professor at MIT who has studied the role of emotions in trading. Kerviel, he said, is a case study in loss aversion.

Lo and Dmitry V. Repin of Boston University have studied traders to determine how stress and emotions affect investment returns. They monitored traders’ vital signs like heart rate, body temperature and respiration as their subjects darted in and out of trades. The findings, while preliminary, suggest that traders who let their emotions get the best of them tend to fare poorly in the markets. But traders who rely on logic alone don’t do that well either. The most successful ones use their emotions to their advantage without letting the feelings overwhelm them.
-JENNY ANDERSON(NYT)