1. Neuroeconomics
Practical Applications of
Neuroeconomics and
Behavioral Finance ©2011
Presented by:
Stacia Eyerly Hatfield
Oct 15, 2011

2. What we’ll cover
• Behavioral Finance
– Framing
– Availability & Anchoring Heuristics
– Optimism & Overconfidence
– Risk and Greed
• Neuroeconomics
– Neurolinguistic Programming
– Somatic Markers
– What is written
– Case studies
– Short term neural changes
• Other

3. The Bad News
Mere presence of a financial advisor causes
cerebral computations to shut down when risky
decisions need to be made
“…one effect of expert
advice is to “offload”
the calculation of
expected utility from
the individual’s brain”
Source: Engelmann JB, Capra CM, Noussair C, Berns GS (2009) Expert Financial Advice Neurobiologically “Offloads”
Financial Decision-Making under Risk. PLoS ONE 4(3): e4957. doi:10.1371/journal.pone.0004957

4. Behavioral Finance
Framing
Availability/Anchoring
Optimism/Overconfidence
Risk/Greed

5. Cycle of Emotions

6. Humans vs Econs
• Biases & Blunders • Resisting Temptations
• Anchoring • Mindless Choosing
• Availability • Self Control Strategies
• Representativeness • Mental Accounting
• Optimism and • Follow the Herd
Overconfidence • Collective Conservatism
• Status Quo Biases • Priming
• Framing

7. Framing
• Importance of carefully presenting alternative
options
– Of 100 patients that have this operation, 90 alive
after 5 years
– Of 100 patients that have this operation, 10 are
dead after 5 years
Source: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, and
Happiness (Caravan Books, 2008)

8. Implement Framing
A. Are you wiling to lose as much as 20% of your
portfolio
B. You’ll likely keep 80% of your portfolio
A. There’s a 77% probability of achieving your
goals
B. There’s a 23% chance that you’ll run out of
money
Source: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, and
Happiness (Caravan Books, 2008)

9. Availability
• Information that’s recent/easiest to access in
an individual's mind
• Post 9/11, most people more concerned
about terrorism than skin cancer or fatal head
injuries from helmet-less bike riding (yet far
higher chance of death from latter two)
Source: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, and
Happiness (Caravan Books, 2008)

10. Availability

11. Availability

12. Availability

13. Implement Availability
• Market volatility still painful…yet
• It’s imperative that advisor bring historical context
each and every time they meet with clients
• Can do this with a quick walk through of a Capital
Markets Outlook (5-6 pages, mostly images)
• Remind them of press motivation-selling ad space!

14. Anchoring
• First number that we hear/think about is the
number we base all following data around.
– Last 3 digits of your phone number
– Add 200. Write it down.
– What year did Attila the Hun ravage
Europe?
• Why mutual funds launch with $10NAV
—seems cheap
Source: Richard H. Thaler, Cass R. Sunstein Nudge, Improving Decisions about Health Wealth, and
Happiness (Caravan Books, 2008)

15. Implement Anchoring
• When reviewing with client, never start with
their portfolio-always talk about greater
capital markets first (the anchor), then go into
client’s individual performance—starting with
longest term number available.

16. Keeping up with the Jones’s

17. Optimism & Overconfidence
• People unrealistically optimistic
– Divorce impossible on your
wedding day
• (50% do)
– 90% of small business owners think
they will succeed
• (50% do)
• Investors expect that their own
portfolios earn 1.5% more than
everyone else's

18. Risk & Greed
• Aging investors willing to assume additional
risk without being rewarded for the
compensation usually associated with such
risk.
• Diminished accuracy for value predictions
• Compelling reason that all investors
should have some professional advice
as they age
Cooper, Woo and Dunkelberg (1988) & Jason Zweig, Your Money & Your Brain (New York,
Simon and Schuster, 2007)

19. Risk & Greed
• Another study showed that when memory is
tested to recall situations of financial gain,
both the anticipation of reward lights up as
well as the long-term memory center.
• People get excited by re-living the experience
of a stock that’s done well. AAPL?
Gregory R. Samanez-Larkin, Camelia M. Kuhnen, Daniel J. Yoo, and Brian Knutson, “Variability in
Nucleus Accumbens Activity Mediates Age-Related Suboptimal Financial Risk Taking” The Journal of

20. Overcoming Risk and Greed
• Implication: Advisors need to work extra hard
to take away the importance of a short term
financial gain, and replace with stories of
about damage done in pursuit of a quick gain.

21. What is Neuroeconomics?
Neuroeconomics:
Combines psychology,
Technology Used:
economics, and neuroscience
•Functional Magnetic
to study how people make Resonance Imaging (fMRI)
decisions. It looks at the role of •PET scans
the brain while individuals •EEG & MEG
evaluate decisions and
categorize risks and rewards.

22. Tactical Neuro Strategies
Neurolinguistic Programming
Somatic Markers
What is Written
Case Studies
Short Term Neural Changes

23. Neurolinguistic Programming
Most impactful word in the English language:
BECAUSE
 “Excuse me, I have 5 pages. May I use the Xerox
machine?”
 “…because I am in a rush?”
 “…because I have to
make copies?”
Robert B. Cialdini, PhD, Yes! 50 secrets from the science of persuasion(Great Britain, Profile Books Ltd
2007)

24. Implement NLP
Mr. Client: “I need you to
fill out the monthly cash
flow statement BECAUSE
your financial plan, which
we use to help you achieve
your goals, starts with this
completed document.”

25. Implement NLP
Ms. Client: “Although the
markets contain risk in that they
can go up and down, there are
other risks to consider—inflation
and longevity risk. BECAUSE we
need to generate enough returns
to address these other risks, we
can’t construct a portfolio
entirely in fixed income.”

26. BTW NLP
Anytime a word is expressed by a financial
advisor that a client or prospect does not
understand, the next 2-3 sentences are largely
unheard.
• Asset Allocation
• Correlation
• Diversification
• Expected Tracking Error

27. Somatic Markers
• Bookmark for the brain
• Help ancient ancestors survive rough living
conditions
• Today’s application: www.willitblend.com
Source: Martin Lindstrom, buyology, Truth and Lies About Why We Buy (Doubleday, 2008)

28. Why Somatic Markers
1. To distinguish themselves from other
financial advisors during the prospecting
period.
2. Get a client to commit to specific goals.
3. Use it to demarcate significant changes down
the road.

29. Implement Somatic Markers
• Dramatic use of images—projector screen
• Use of sound—play a meaningful song (Baby
Boomers connect with the Rolling Stones)
• Unexpected location: hotel lobby by the fire,
conference room of a public library, donut
shop during the early morning frying time
Source: Lindstrom

30. Somatic Markers
WARNING!

31. The Written Word
• Volunteer Project
– Active Form vs.
“…commitments that – Negative consent
are made actively have
more staying power
than those that are
made passively.”
Source: Cialdini, Yes!; Personality and Social Psychology Bulletin, Vol. 22, No. 2, 133-147
(1996)DOI: 10.1177/0146167296222003

32. Implement Written Word
• Provide yellow notepad (or firm stationary)
• If a couple, both members participate in
activity
• Bring original version at every annual meeting
(Great tool for clients demanding to go to all cash)
Source: Cialdini

33. Case Studies
• Error exposure training
• Used with fire-fighters
– Depicted incidents containing errors of
management with severe consequences in fire-
fighting outcomes
– Same set of case studies, but incidents managed
well, no consequence
Source: Wendy Joung, Beryl Hesketh, Andrew Neal Using "War Stories" to Train for Adaptive Performance: Is it Better
to Learn from Error or Success? Applied Psychology VL: 55 NO: 2 PG: 282-302 YR: 2006 ON: 1464-0597 PN: 0269-994X
University of Sydney, Australia; University of Queensland, Australia

34. Implement Case Studies
• Build (mental) storybooks for your clients

35. Case Studies: Caution
• Stories powerful tool to influence behavior
• When given statistical evidence & anecdotal
story telling opposite side, individual far more
swayed by story—suboptimal decisions made
• Be even handed when telling stories
Source: Wainberg, James, Kida, Thomas and Smith, James F., Stories vs. Statistics: The Impact of Anecdotal Data on
Accounting Decision Making (March 12, 2010). Available at SSRN: http://ssrn.com/abstract=1571358

36. Short Term Neural Changes
1. Dopamine
2. Mirror Neurons
3. Amgydula

37. Dopamine
• Neurotransmitter substance associated with
motivation and award
• Pleasure drug giving natural high when you get
what you want
• Overtime, getting what you expected produces
NO dopamine (brain likes the unexpected)
• Reward you expected fails to
materialize, dopamine dries up
Source: Michael Shermer The Mind of the Market (Henry Hold & Co. New York, 2008) & Jason
Zweig Your Money & Your Brain (Simon & Schuster New York, 2007)

38. Dopamine in Finance
• Short term release (15-30 minutes)
• Seeking that “hot stock”
• Counter with long term picture
 Use stories to explain how hot picks affect a
portfolio over sound asset allocation
Source: Michael Shermer The Mind of the Market (Henry Hold & Co. New York, 2008)
Jason Zweig Your Money & Your Brain (Simon & Schuster New York, 2007)

39. Dopamine Can Be Your Friend
• Prisoners Dilemma
– Trust someone so you both walk out better off
– Choose to destroy your partner and walk out a big
winner
– Choose to violate each other at cost to both
yourself and the other player
• Cooperative partners strongly light
up for dopamine
• Become a trusted advisor!
James Rilling, D.A. Gutman, T.R. Zeh, G. Pagnoni, G.S. Berns, and C.D Kilts, “A Neural Basis for
Social Cooperation,” Neuron 35 (July 18, 2002): 394-404

40. Mirror Neurons
Same circuits light up in brain when watching
someone perform a function, as doing the
function (empathy)
•Crying at the movies
•Cringing when our favorite
athlete misses a clutch
shot
Source: Tania Singer Neuroeconomics Chapter 17: Understanding Others: Brain Mechanisms of
Theory of Mind and Empathy Edited by Paul W. Glimcher, Colin F. Camerer, Ernst Fehr, & Russell
Poldrack (Elsevier, 2009) & Michael Shermer The Mind of the The Market

41. Implement Mirror Neurons
• Smile!
• Study of faces shown @ 1/60th
second: Happy, Sad, Neutral
• Drank a “novel lemon-lime beverage”
• More consumed after happy faces
• AND willing to pay twice as much!
• More pleasant, sincere, sociable, competent,
honest, highly-esteemed (be genuine)
Piotr Winkielman and Kent C. Berridge “Unconscious Emotion,” CURRENT DIRECTIONS IN PSYCHOLOGICAL SCIENCE 2004 Vol 13 No. 3
120-123 & Sekar, Samuel Babu, Importance of Smile in Managerial Communication. Proceedings of 6th Asia-Pacific ABC Conference
on Management Communication on the theme "Management Communication: Trends & Strategies“ Conducted by IIM, Ahamedabad,
McGraw Hill. Available at SSRN: http://ssrn.com/abstract=976137

42. More mirror neurons
• Mimic body language of
whomever sitting
across from you
• More you seem familiar
to themselves, more
likeable and
trustworthy you are
Source: Lindstrom, Buyology!

43. Amygdula
• Ancient part of the brain dealing with
instinctual emotions
• Great for ancestors
• Not great for modern day technology
• Surges are very short
Source: Zweig, Your Money and Your Brain

44. Easy Tactics

45. The Pursuit of Happiness
What keeps you up at Night
Aging
Time

46. Major Concerns

47. Top Priorities

48. [2010

49. Indicator 28 – Use of Time

50. Indicator 28 – Use of Time

51. Calculus of Happiness
• Understanding client personality types
• Era client grew up in

52. 10,957
Number of days in 30 years
• How many cruises can one take?
• How many rounds of golf can one play?
• How many hours of volunteer work will you really
do?
•Important exercise: have clients create a
roadmap of what might happen in 10,957 days

53. Summary
• Behavioral Finance being discussed
• Data is there-incorporate into your client
interactions
• Market volatility is forcing the conversation to
change drastically.
• What behavioral traps are you falling into?

54. Appendix