In my classes I talk about how in economics the key question is often getting the right amount of something. Not too much or too little. For example, I used the Supply and Demand Game to show how markets, by reaching equilibrium, produce just the right amount of a good. Also, it comes up when I discuss Allocative Efficiency, when the amount of a public good produced makes the marginal cost equal the marginal benefit and social welfare is maximized. Any other quantity would be sub-optimal.
But in this case of Wall Street traders, it inolves brain chemistry and neuroeconomics. Key excerpts:
"A different approach to reducing the irrationality of Wall Street can be found in new research led by Steve Sapra and Paul Zak, neuroeconomists at Claremont Graduate University. Dr. Zak got the idea for the paper after spending time with leading analysts and traders at a conference. "These guys are a pretty weird bunch," he says. "They're very rational and very competitive."
Dr. Zak wanted to see if he could find the genetic signature of this personality type. Did certain genes correlate with investment success? What's the difference between the prudent decisions of somebody like Warren Buffett—he's famously unwilling to invest in bubbles—and the reckless bets that cause so many other traders to lose vast sums of money?
The scientists focused on a short list of genes that are known to affect the activity of dopamine, a neurotransmitter in the brain.
In recent years, it's become clear that dopamine helps to regulate decisions involving risk and reward, allowing us to experience both the thrill of getting what we want and the pain of losing it all.
Consider the decision to invest in an initial public offering. As Dr. Zak notes, these investment offerings are pretty exciting, leading "to lots of dopamine activity," he says. "There's the thrill of novelty and the potential for a big future reward." The problem, however, is that 63% of newly public companies fail within 10 years.
The challenge for investors, then, is to balance the allure of the new stock against the risk that the company might go bankrupt. Such calculations are often extremely difficult, even for experienced traders.
So what did the scientists find? It turned out that successful traders—Drs. Zak and Sapra measured success in terms of longevity on Wall Street—tended to hit a sweet spot of dopamine activity; their genes kept them from experiencing either very high or very low levels of the molecule. These prosperous professionals were much more likely to have so-called Goldilocks genes, placing them solidly in the middle of the dopamine distribution.
"The best traders are willing to take risks," Dr. Zak says. "They definitely want to make lots of money. But they're also able to take a long-term perspective and check their impulses. Being able to balance these competing interests seems to require a balanced dopamine system.""
Adam Smith vs. Bart Simpson (which has links to other related posts on neuroeconomics)
Are Women Better At Investing Than Men? (which has links to other posts on how brain functioning affects the stock market)
How Our Brains Help Create Financial Bubbles
Did Economist Hyman Minsky Predict The Financial Crisis?
Interesting Theory on Stock Market Fluctuations
Can Testosterone Help Women Earn More Money?
Male sex hormone may affect stock trades