What is neuroeconomics ?

Neuroeconomics is the study of economic decision-making that combines the fields of neuroscience, economics and psychology. 

Neuroscience allows us to better understand the decision making process.

Neuroeconomics measures brain activity before, after and during the decision making process. Neuroscientific tools and methods include brain imaging, electrical brain stimulation, single-neuron measurement, diffusion tensor imaging and psychophysical measurement.

In brain imaging, magnetic resonance imaging (MRI) tracks blood flow in the brain, a proxy for neural activity, during stimulus events or behavioural responses. 

Psychophysical measurements measure indicators like heart rate, blood pressure, sweating in the palms and pupil dilation. 

Examples of uses of neuroeconomics

Neuroeconomics aims to evaluate conventional economic theory, like the Rational Choice theory, which states that individuals evaluate risks objectively to make choices that are most beneficial to them. This theory does not consider the complexities of the human mind and variables that could influence a decision.

Through the study of human psychology, behavioural science studies have argued that people do not always follow the Rational Choice theory and can make choices influenced by their emotions.

Neuronomics for traders and investors

Investors' psyche is governed by two principal emotions: fear and greed. Today, we have “Fear and Greed” indices which represent the emotions driving financial markets. 

Interpreting market emotions can give investors useful insights to understand when a market is oversold or overbought.

Behavioural finance pioneers, Robert Shiller and Richard Thaler, have applied psychological theories to understand financial markets better. Their studies suggest that people tend to show “a wishful thinking bias, believing what they want to believe” and tend to hang “onto past beliefs long after they should have abandoned them”. 

Limitations to neuroeconomics

It’s important to note that neuroscience is in its nascent phase and more technological advancements and research are needed to fully unlock the potential of its use.

“A downside concern is the overselling of what is likely to happen in five years' time. The brain literally has astronomical complexity. And I don't think anybody would dispute that understanding how the human brain works is the most complex challenge that scientists face,” said Jonathan Cohen,co-director of Princeton Neuroscience Institute.

“I think a deep understanding that will be useful to and appreciated by economists is decades away. But we'll never get there if we don't start somewhere.”