Psychology and neuroscience applied to financial decision-making.

Abstract

All financial bubbles eventually burst and cause financial crises. In 2008 the US housing bubble burst, causing the global economy to suffer for 4 years. While the 2008 crisis received considerable attention because of its global impact, in the 21st century alone, there have been more than 10 financial crises. While economic, political and legal analysis of the crises have dominated academia, this dissertation argues that an interdisciplinary approach to financial market analysis is required to better understand why they occur. This argument is based on the idea, that the choices of traders are at the core of this issue, and consequently an understanding of trader decision-making behavior was required. Economic models of decision-making are unable to explain this behavior, as they assume decision-making to be an entirely rational process. To address this limitation, findings in neuroscience, psychology and biology are considered. Using this approach, this chapter outlines the role of different neural mechanisms, gut-feelings and hormonal states, that facilitate irrational behavior and increase a trader's susceptibility to partake in bubble markets.