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Hersh Shefrin
Behavioral Insights into Governance and Risk November 2014 Hersh Shefrin Mario L. Belotti Professor of Finance Santa Clara University Copyright, Hersh Shefrin 2014 Something in Common Copyright, Hersh Shefrin 2014 1 Wherever Portfolios are Managed 2 Oversight Copyright, Hersh Shefrin 2014 3 Outline 1. Brain Circuitry, general issues 2. Psychology of risk 3. Implications for finance Copyright, Hersh Shefrin 2014 4 1. Brain Circuitry & Genes Copyright, Hersh Shefrin 2014 5 Mischel Marshmallow Experiment Copyright, Hersh Shefrin 2014 6 What Lights Up? Copyright, Hersh Shefrin 2014 7 2. Psychology of Risk Kahneman-Tversky Copyright, Hersh Shefrin 2014 8 Emotions SP/A Approach Copyright, Hersh Shefrin 2014 9 Robyn Dawes 10 Copyright, Hersh Shefrin 2014 Copyright, Hersh Shefrin 2014 Amy Cuddy Copyright, Hersh Shefrin 2014 Copyright, Hersh Shefrin 2014 Copyright, Hersh Shefrin 2014 Hormones Copyright, Hersh Shefrin 2014 16 Copyright, Hersh Shefrin 2014 Circuitry • Kuhnen and Knutson, Neuron, 2005 • Two key brain regions activated before people make risky choices. Copyright, Hersh Shefrin 2014 18 NAcc & Anterior Insula • fMRI of subjects. • Nucleus accumbens activation preceded choice of risky alternatives. • Anterior insula activation preceded choice of safe alternative. Copyright, Hersh Shefrin 2014 19 Emotional Circuitry Copyright, Hersh Shefrin 2014 Copyright, Hersh Shefrin 2014 20 Casinos • Surround guests with inexpensive food, free liquor, surprise gifts, potential jackpot prizes. • Anticipation of rewards activates the NAcc, increasing likelihood of individuals switching from riskaverse to risk-seeking behavior. Copyright, Hersh Shefrin 2014 21 3. Implications for Finance Copyright, Hersh Shefrin 2014 22 Lehman Fails High Power or Low Power Pose? Copyright, Hersh Shefrin 2014 23 Testosterone & Cortisol • Herbert and Coates. • How do levels of testosterone and cortisol change with a trader’s success or failure? Copyright, Hersh Shefrin 2014 24 Findings • Trader's morning testosterone level predict day's profitability. • Cortisol did not rise when traders lost money. – Individuals not more cautious. • Instead, trader's cortisol level rose with both the variance of his trading results and the volatility of the market. Copyright, Hersh Shefrin 2014 25 Hypothesis • As volatility increases, hormones shift risk preferences and can affect a trader's ability to engage in rational choice. • Over a certain peak, testosterone impairs the risk assessment of traders. – Inverted U-shaped response curve. Copyright, Hersh Shefrin 2014 26 Male Competition Copyright, Hersh Shefrin 2014 27 Coates’s Thoughts • If you keep winning … • When that happens to animals … • At the center of the market … Copyright, Hersh Shefrin 2014 28 Governance Copyright, Hersh Shefrin 2014 29 Copyright, Hersh Shefrin 2014 Copyright, Hersh Shefrin 2014 Conclusion 1. Brain Circuitry, general issues 2. Psychology of risk 3. Implications for governance in financial services firms Copyright, Hersh Shefrin 2014 32
