Somatic Signals: Rethinking Finance with Neuroeconomics
Written and accurate as at: Apr 19, 2024 Current Stats & Facts
Neuroeconomics is an emerging field of research that utilises psychology, economics, and neuroscience to understand areas such as financial decision-making better. For many years, the concept of rationality was bound by the idea that only mental (internal) and, at times, environmental (external) factors were important in decision-making. However, social rationality, neuroeconomics and the somatic marker hypothesis shed new light on how we make decisions by considering emotional contexts.
Ecological and social rationality considers emotions, social norms, and how we adapt to our environments. Developments in this line of thinking led neuroscientist Antonio Damasio to develop the Somatic Market Hypothesis, proposing that emotions are crucial in decision-making, especially under uncertainty.
So, what is the Somatic Market Hypothesis (SMH)?
When constructing emotion, our minds rely on physiological feedback from the body and how we interact with our environment. Simply put, our body and mind are one whole rather than two separate parts, known as embodiment.
SMH proposes that emotions and bodily functions significantly influence decision-making, an idea that is foundational in neuroeconomics. Recent studies have proved this to be correct by implementing electronic wristbands to monitor real-time physiological responses, such as heart rate, blood pressure, and body temperature, during decision-making. These studies demonstrate how our body’s psychophysiological activation influences financial risk analysis in professional traders. But how do we apply this growing body of research to our financial decisions?
- Emotional Decisions: The financial world naturally produces times of uncertainty, and during these times, our emotions significantly impact our decisions. Check in with yourself and your feelings before making decisions. Are you feeling confident? Do you feel anxious? Is this affecting your decision-making in scenarios such as buying/selling stocks?
- Ecological Rationality: Financial decision-making may be enhanced by drawing on environmental cues and information for adaptability. For example, looking at economic indicators and social factors, not just analytical data, when considering market trends.
- Embodied Emotion: The idea that emotions develop due to physiological responses implies that investors might “feel” their reactions to risk, e.g. an increased heart rate or nausea may lead to more conservative financial decisions
- The Role of Heuristics: Simple heuristics may be more effective than complex analyses in specific contexts. Financial advisors might use heuristics to make quicker yet more effective decisions in fast-moving environments.
Tools for better understanding your body/emotions -
- Emotional tracking apps: these apps help you gain insight into shifts in your feelings, the contributing factors and how your decision-making may be impacted
- Mindfulness and meditation: by increasing self-awareness, you may better identify and manage emotional reactions during financial decision-making
- Emotional AI: new developments in AI are looking into developing programs that account for emotions whilst investing
- Consulting with a financial advisor: by having discussions with a financial advisor who understands behavioural economics, you can better identify when your decisions may be influenced by emotions or cognitive biases
- Emotional regulation: by nailing these skills, you will become better at managing your emotions and, therefore, better equipped to make sound financial decisions.
By acknowledging the importance of emotional influences, we can better navigate the intricacies of financial decision-making. This holistic understanding encourages us to consider the logical aspects of our financial choices and psychological and emotional factors, ultimately leading to wiser and more sustainable financial decisions in an ever-evolving economic landscape.