From the Emotional Finance blog:
Hermit crabs rely on acquiring discarded shells for their protection
and are constantly on the look-out for better shells. However, faced
with environmental stress they prefer to stick with their old shell,
however unsuitable, than risk moving to a new one[i].
Experiments with rats show that under stress habitual behaviour
persists longer in the face of changed reward structures – the market
conditions may have changed but stressed rats take longer to spot this
than unstressed ones. In stressful conditions the more rigid ‘habit’
memory system is favoured over the more flexible ‘cognitive’ memory[ii].
As we learn more about the neuroscience of decision-making,
cross-species research is starting to help us understand more about how
humans think and decide. In our daily lives and at work we are faced
with the need to navigate complex situations with limited cognitive
resources. A major strategy that evolution has equipped us with (just
like hermit crabs and rats) is the development of habitual responses.
These can be quite complex behaviours. For example the first couple of
journeys driving to a new workplace can involve a good deal of
route-finding and thinking things through to achieve the goal of
arriving at your intended destination. After sufficient repetition the
journey becomes a habit. There has been a shift from goal directed
cognition to habitual behaviour.
Habitual responses have value because they free us to devote
cognitive resources to what is novel or challenging. However, they are
also rigid and inherently less adaptable to changing conditions. Just
like rats and hermit crabs, there is evidence that humans fall back on
rigid habits when stressed and become less able to respond flexibly to
environmental signals[iii].
There is increasing evidence that this stress response can be an
important factor in financial markets. For example, in one study of
investment bank traders, we used a physiological measure (heart-rate
variability) of moment by moment flexible responding to environmental
signals. The traders’ ability to respond flexibly was significantly
impaired in volatile market conditions[iv].
So just at the point where fund managers need to be at their creative
best, the natural inclination may be to freeze into habitual behaviour
patterns. What can be done to counter this?...MORE
