Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility

Abstract

We use measures of neural activity provided by functional magnetic resonance imaging (fMRI) to test the “realization utility” theory of investor behavior, which posits that people derive utility directly from the act of realizing gains and losses. Subjects traded stocks in an experimental market while we measured their brain activity. We find that all subjects exhibit a strong disposition effect in their trading, even though it is suboptimal. Consistent with the realization utility explanation for this behavior, we find that activity in the ventromedial prefrontal cortex, an area known to encode the value of options during choices, correlates with the capital gains of potential trades; that the neural measures of realization utility correlate across subjects with their individual tendency to exhibit a disposition effect; and that activity in the ventral striatum, an area known to encode information about changes in the present value of experienced utility, exhibits a positive response when subjects realize capital gains. These results provide support for the realization utility model and, more generally, demonstrate how neural data can be helpful in testing models of investor behavior.

Business Ethics: The Promise of Neuroscience

“…As such, business ethics joins a wide range of scholarly fields employing neuroscience methodology to study human decision making, including economics Frydman et al, 2014), social psychology (Amodio, 2010), marketing (Karmarkar et al, 2015), and organizational behavior (Becker et al, 2011). Salvador and Folger (2009) provide an excellent review of neuroscience research in business ethics; although still in a formative stage, interest in the topic is increasing, as this special issue attests.…”

On the neural substrates of the disposition effect and return performance

“…The neural data coming from neurofinance experiments can be helpful in testing models of investor behavior (Frydman et al, 2014). A recent study confirmed the disposition effect is due to bounded rationality, but not of the narrow framing type (Frydman et al, 2014).…”

“…A recent study confirmed the disposition effect is due to bounded rationality, but not of the narrow framing type (Frydman et al, 2014). The authors conducted the study in an experimental market where participants traded stocks while their brain activity was measured using functional magnetic resonance imaging (fMRI).…”

“…Here, we experimentally reassess the disposition effect adopting the neurofinance perspective (Frydman et al, 2014), but measure brain activity with electroencephalogram (EEG) rather than fMRI. EEG is usually employed to track electrical activity in the brain.…”

“…The design of the experiment follows a previous protocol (Frydman et al, 2014). Our sample was made up of 12 undergraduates (all male, age range 18 to 29, mean age 22.2) and five professional stock traders (all male, age range 21 to 37, mean age 30.2).…”