Taking a look at our emotional and psychological relationships with money and finance

On the false contrast between rationality and emotion

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It is common to contrast emotions with rationality (usually in tandem with proclaiming the superiority of reason over emotion). Take for example this post on the changingminds blog. It is also the claim at the heart of Ayn Rand’s morally barren apologia for the extremes of modern capitalism, ‘Atlas Shrugged‘. In this book she claims that:

“Happiness is not to be achieved at the command of emotional whims . . . Happiness is possible only to a rational man, the man who desires nothing but rational goals, seeks nothing but rational values and finds his joy in nothing but rational actions”

Economists too, commonly either discount emotions or treat them simply as a component of the future utility of a rational choice.

Psychologists have often perpetuated this split and have, until recently, tended to study reason and emotions as entirely separate phenomena. However, during the last two decades, evidence has been building that human reason and emotion are inextricably linked. In an article published in the Annual Review of Psychology, the distinguished neuroscientist Elisabeth Phelps notes that

“Investigations into the neural systems underlying human behaviour demonstrate that the mechanisms of emotion and cognition are intertwined from early perception to reasoning. These ļ¬ndings suggest that the classic division between the study of emotion and cognition may be unrealistic and that an understanding of human cognition requires the consideration of emotion.”

Figure 21 from Charles Darwin's The Expression...

Figure 21 from Charles Darwin’s The Expression of the Emotions in Man and Animals. (Photo credit: Wikipedia)

If Phelps is right and separating emotions from reason is a lost cause, does this mean that humans are doomed to irrationality? Actually, there is good evidence that our emotions can often be a useful tool in making rational choices and in taking effective action. Work by Antonio Damascio, Antoine Bechara and others shows that in many cases our emotional responses to information can lead us to the right conclusions more rapidly than our reasoning. There is evidence too that patients with damage to the areas of the brain responsible for emotion do fine in intelligence tests in the lab but are incapable of everyday decision-making. I caught up with Antoine Bechara at a neuroeconomics conference we both attended and asked him about emotions and decision-making. You can listen to the interview in the audioclip below.

http://emotionalfinance.files.wordpress.com/2013/02/bechara.mp3 Interview with Prof. Antoine Bechara

So how can emotions act as an instrument of rational choice? Let’s take a simple example. Emotions direct attention. Pause for a moment to pay attention to all of the sensory data you are receiving right now. The hum of your computer, a reflection in the corner of the screen. The feel of your clothes on your skin and so on. We get so much information from our environment that we cannot process it all. Our emotions direct attention.

Now imagine you are driving to work on a familiar route. You have a passenger you are chatting to, music is playing on the radio and you are driving pretty much automatically as you chat. Then suddenly a small child runs in front of your car.

laying down on the job, in the middle of the r...

(Photo credit: sean dreilinger)

You experience a surge of fear and adrenalin and all of your cognitive and physical resources are focused on one simple goal – avoid hitting that child. Your emotional reaction is what enables your rapid action to avoid harming the child. Similarly in in the fast moving and high stakes world of financial trading, emotions come into play. In the audio track below a financial trader talks about experiencing fear during the 2008 financial crisis.

A trader’s perspective
trader

Trader (Photo credit: killthebird)

Here, as in the car, fear plays an important role rapidly directing attention to important information and cuing action.

Emotions can of course also mislead us (just like our other thinking processes). It is all too easy to carry emotions from one situation into another. A common problem for traders is the tendency for emotions from a loss or gain on one trade to carry over and affect later trades. A big loss for example may trigger an increased willingness to bear risk to “win the loss back”.

However, effective regulation of emotions does not mean eliminating them. First, it is not possible and suppressed emotions may affect behaviour even more powerfully. Second, we risk losing access to the important signals emotions carry. We need, instead, to develop skill in recognizing the ebb and flow of our emotions and develop a critical appreciation of the role they play; recognizing that like most of the tools we deploy in making rational decisions they have both strengths and weaknesses.

8 Responses to “On the false contrast between rationality and emotion”

  1. emotionalspirtis

    But what does this mean for economics? The functional role of emotions needs a singular reference point which is rational decision making (=functional free markets?). Is that reference point somehow emotionless? Since we should not surpress them I guess it should have some room for emotions. Also, does this mean that for short periods emotions can be “rational”, while in the long-run they can only be irrational or meaningless b/c the referencepoint is already specified?

    Reply
  2. Mark Fenton-O'Creevy

    Mostly I would say that economists mistakenly believe there to be only one rationality – that which underlies the normative prescriptions of neoclassical economics. Actually many behaviours which economists persist in seeing as irrational turn out to remarkably adaptive in a complex messy social world in which we only ever have partial information and in which trust in providers of information is a real issue. See for example the work of Gerd Gigerenzer.

    Reply
    • emotionalspirtis

      I agree that neoclassical economics usually assume one rationality. But I think for behavioral economics it is often also true. Gigerenzer is indeed different. Still I wonder: how do you specify the case in which emotions mislead us? Ex-post it is easy to say that you got carried away, if you make losses. But then again emotions are helpful in a lot of situations. For me it would not make sense to say emotions=gains=rational and emotions=losses=irrational.

      Reply
      • Mark Fenton-O'Creevy

        I think this misses the point. Rather than equate emotions with irrationality, we should understand them as just one tool for thinking. Just as we can make errors of judgement in calculating a probability or in carefully analyzing a data set, so we can make errors of judgement in drawing on our emotions – for example mistaking the mood which carries over from an earlier loss for genuine information about the latest trade we are considering or the residual anger from an argument with a lover for relevant information in a customer service encounter.

        By the way, I don’t regard myself as a behavioral economist. Behavioural economics and its close cousin, behavioural finance are mostly concerned with very simple models of human behaviour which lead to computable predictions which can be used to understand aggregate market behaviour. I am much more interested in understanding the behaviour of individuals and in how both context and individual differences interact to influence such behaviour. This requires much richer models of human psychology and the social systems and institutions in which we partake. Thus I am very interested in the complex multiple rationalities which underlie human behaviour.

  3. emotionalspirtis

    I dind’t take you as a behavioral economist. I favour your approach. I just want to know how you make the judgement whether or not an emotion-based decision is right or wrong. For example, you could say that investment decisions shouldn’t be based on anger but on trust and fear. Then you would make some sort of emotional normative order for investment markets in your example. But the anger from your loss could also be your motivation to not make the same mistake again. So anger is relevant for learning. I think the adaptive tool box analogy somehow misses this point. First of all who uses the toolbox and in what way? It reminds me of an Homunculus argument.

    Reply
    • Mark Fenton-O'Creevy

      I take the point about the homunculus argument, but I guess you are the tools that you use. I see no more of a problem in saying that you use your emotions to think than in saying you use your eyes to see.

      Reply

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