Wednesday, September 24, 2014

Trading the Nucleus Accumbens: Using MRI Scans to Top-tick a Bubble


MRIs of Careful People Can Predict When Bubbles Will Pop
In the 1630s, Holland was gripped by the world’s only known case of “tulip mania.” The intensely colored flowers were already a luxury item before then, but their prices leaped when tulips with flame patterned petals hit the market, and they continued rocketing to previously incomprehensible levels. The price for a single bulb soon far surpassed what a skilled worker could make in an entire year, and others commanded enough money to buy homes or land.

It didn’t last, of course. The inevitable and dramatic crash in prices left people puzzling over the tulip bubble for centuries to come. An early account blamed it on a group delusion, fueled by emotional highs spreading through the population like an infection. Subsequent observers found reasons in the Dutch market structure of the time, or government policies that encouraged wanton trading, or even fallout from the bubonic plague. In this more staid view, people were logically trading based on information the market presented to them. Emotions, or other vexations of human psychology, had no role in it.

Hundreds of years and many bubbles later, people are still trying to work out how the dramatic overvaluations, then stunning collapses, of bubbles come to pass. A recent study turned to the wellspring of human psychology—the brain—and found bubble-related activity there, including a signal in some people that predicted the ensuing crash.

“We don’t know why prices go up in a bubble, or why the crash starts,” says Alec Smith, who conducted the study while a postdoctoral fellow in Colin Camerer’s lab at the California Institute of Technology in Pasadena. “Putting people in the scanner is one way to try to understand this.”

The researchers created an experimental bubble by having about 20 people come at a time to their lab and trade made-up assets online. In each trading period, subjects could buy or sell one asset unit. In the course of 50 trading periods (in each period, each participant could buy or sell one asset unit), bubbles reliably inflated and then popped. Simply swapping imaginary assets in a lab provoked some of the feverish atmosphere that marks real bubbles, with people growing more excited as the top of the bubble approaches. And as in real bubbles, there were people who cashed in by selling assets before the bubble peaked, and others who continued to buy and then lost big when the bubble popped.

This excitement reached outside of the room where most participants were trading, to the few ensconced in an fMRI brain scanner while they traded in real time with the others. In all, the researchers tracked brain activity in 41 people, with special attention to the nucleus accumbens (NAcc). This knot of neurons near the bottom of the brain is active in processing rewards—anything that feels pleasurable—and underlies learning from them. It also features prominently in addiction research, where reward-processing goes awry.....MORE
See also one of my favorite pieces of financial scholarship:
Prop Trading the South Sea Bubble: Hoare's Bank 1720