A fascinating piece in the journal Neuron:
In the Mind of the
Market: Theory of Mind Biases Value Computation during Financial Bubbles by
Benedetto De Martino, John P. O’Doherty, Debajyoti Ray, Peter Bossaerts, and
Colin Camerer
Summary
The ability to infer intentions of other agents, called theory of
mind (ToM), confers strong advantages for individuals in social situations.
Here, we show that ToM can also be maladaptive when people interact with
complex modern institutions like financial markets. We tested participants who
were investing in an experimental bubble market, a situation in which the
price of an asset is much higher than its underlying fundamental value. We
describe a mechanism by which social signals computed in the dorsomedial
prefrontal cortex affect value computations in ventromedial prefrontal cortex,
thereby increasing an individual’s propensity to ‘ride’ financial bubbles and
lose money. These regions compute a financial metric that signals variations in
order flow intensity, prompting inference about other traders’ intentions. Our
results suggest that incorporating inferences about the intentions of others
when making value judgments in a complex financial market could lead to the
formation of market bubbles.
Here is the WSJ piece on the research:
The WSJ piece summarizes the research succinctly:
“…“People seem to be
buying,” Prof. Camerer says, “because they think they can sell to somebody else
who isn’t able to control himself as well as they can or isn’t as prescient as
they are.”
In other words, as
prices rise and you intensify your search for that “greater fool” you can sell
to, you may get distracted from noticing that the greatest fool of all is you.”