The bear-market overshoot and why it hurts so much
Pain because I bought GM junk bonds?
Posted October 13, 2008
As we have recently watched the media reports of the stock market declines throughout the world, we all repeatedly hear references to physical discomfort. We hear of the pain of investors on Wall Street. We hear of the pain of so-called Joe Six-Pack and his 401k, trying to keep a stiff upper lip as he heeds the admonition, "Don't panic"; all the while his retirement is being postponed anywhere from 5 to 10 years.
Is this pain real or metaphorical?
I recall a study published last year in "The Journal Of Neuroscience", which found that individuals process information about financial loss through mechanisms in the brain similar to those used to process physical pain.
This study focused on the part of the brain known as the striatum. It is an area of the brain that processes signals in the brain's consideration of rewards and defensiveness. There had been other studies which demonstrated increased activity in the striatum when study subjects were given monetary awards; the same area showed no activity when money was lost. It appears that the negative value human beings associate with the loss of money stems from an evolutionarily ancient brain construct involved in pain and fear.
So, we have financial pain.
The methodology of the study involved men and women learning to associate abstract image cues with certain amounts of money. Subjects would be shown the original image, followed by a screen disclosing whether they had won the associated amount of money, lost that money, or received nothing.
Using neuroimaging, researchers showed that the portion of the striatum toward the front of the brain was more active when study subjects did better than they expected, or when they were made at ease with the knowledge that they did not lose as they might have expected. However, losing money or receiving less than they expected resulted in activity in the portion of the striatum towards the back of the brain. These findings were not unlike those found by animal researchers: there is a gradient of reward- and aversion-based activity across the striatum, from the front to the back.
How the systems of the brain dealing with reward and loss interact could give insights as to why some individuals gamble more than others; and why there exists the extreme-the addicted gambler.
It will be interesting to see how the investing class approaches this week. What part of the striatum will be dominant? Is there something wrong with my striatum if I choose to buy General Motors junk bonds, with their 30% yield? Will the pain I feel should GM subsequently declare bankruptcy be the result of a striatum which does what evolution had told it to do? Or will all that pain I feel be the result of the whipping my wife gave me because I did buy those GM junk bonds?