Collaborative Research: Understanding and Predicting Asset Price Bubbles from Brain Activity

California Institute Of Technology, Pasadena CA

Investigators

Abstract

The research team includes researchers at Caltech and Virginia Tech with expertise in Economics and Cognitive Neuroscience. They will study how the human brain works when faced with the tasks that are part of buying and selling in asset markets. They plan to use lab experiments with market designs that encourage the formation of market bubbles, periods where the price paid for an asset is well above the actual value of the asset. They want to determine whether traders who buy at high "bubble" prices are systematically different than other more cautious buyers. They will use brain imaging techniques and analyze the resulting data to test whether neural activity can predict how large a bubble will become and how long it will last. Because market bubbles can have serious consequences on the broader economy, understanding more about the possible causes of bubbles is important for financial market regulation. The project studies the behavioral ecology of trader types, predictive 'decoding' of when bubbles will form and crash, and neural activity during bubbles. For economics, the project contributes to our scientific understanding of bubble dynamics by helping us understand why and how people participate in bubbles. For cognitive neuroscience, studying asset prices is one way to advance the science of understanding how the brain computes a complex dynamic value that changes over time depending on the reactions of others. The combination of behavioral observation and neural measures will give us data that will help us better understand how emotions such as 'irrational exuberance', social influences like 'herd behavior', and momentum trading all affect asset markets.