The Influence of Affect on Beliefs, Preferences and Financial Decisions

Abstract

Recent research in neuroeconomics suggests that the same brain areas that generate emotional states are also involved in the processing of information about risk, rewards and punishments. These findings imply that emotions may influence financial decisions in a predictable and parsimonious way. Our evidence suggests that affect -- generated either by exogenous manipulations, or endogenously by outcomes of prior actions -- indeed matters for financial risk taking, and that it does so by changing preferences as well as the belief formation process. Positive and arousing emotional states such as excitement induce people to take more risk, and to be more confident in their ability to evaluate the available investment options, relative to neutral states, while negative emotions such as anxiety have the opposite effects. Moreover, beliefs are updated in a way that is consistent with the self-preservation motive of maintaining positive affect and avoiding negative affect, by not fully taking into account new information that is at odds with the individuals' prior choices. Therefore, characteristics of markets, economic policies or organization design that have an impact on emotional brain circuits may influence decision making and affect important outcomes at the individual and aggregate level