Hermit crabs rely on acquiring discarded shells for their protection and are constantly on the look-out for better shells. However, faced with environmental stress they prefer to stick with their old shell, however unsuitable, than risk moving to a new one[i].
Experiments with rats show that under stress habitual behaviour persists longer in the face of changed reward structures – the market conditions may have changed but stressed rats take longer to spot this than unstressed ones. In stressful conditions the more rigid ‘habit’ memory system is favoured over the more flexible ‘cognitive’ memory[ii].
As we learn more about the neuroscience of decision-making, cross-species research is starting to help us understand more about how humans think and decide. In our daily lives and at work we are faced with the need to navigate complex situations with limited cognitive resources. A major strategy that evolution has equipped us with (just like hermit crabs and rats) is the development of habitual responses. These can be quite complex behaviours. For example the first couple of journeys driving to a new workplace can involve a good deal of route-finding and thinking things through to achieve the goal of arriving at your intended destination. After sufficient repetition the journey becomes a habit. There has been a shift from goal directed cognition to habitual behaviour.
Habitual responses have value because they free us to devote cognitive resources to what is novel or challenging. However, they are also rigid and inherently less adaptable to changing conditions. Just like rats and hermit crabs, there is evidence that humans fall back on rigid habits when stressed and become less able to respond flexibly to environmental signals[iii].
There is increasing evidence that this stress response can be an important factor in financial markets. For example, in one study of investment bank traders, we used a physiological measure (heart-rate variability) of moment by moment flexible responding to environmental signals. The traders’ ability to respond flexibly was significantly impaired in volatile market conditions[iv].
So just at the point where fund managers need to be at their creative best, the natural inclination may be to freeze into habitual behaviour patterns. What can be done to counter this?
As with most aspects of human behaviour, simply being aware of a behavioural tendency is not sufficient to eliminate it. If this were true, diets would be easy. The human capacity for self- regulation is useful but soon becomes exhausted. What can help is a dual approach which combines systems which aid regular self-monitoring and reflection combined with lifestyle approaches which help reduce the impact of stress.
This article was commissioned by Essentia analytics and first published here.
[i] De la Haye, K. L., Spicer, J. I., Widdicombe, S., & Briffa, M. (2011). Reduced sea water pH disrupts resource assessment and decision making in the hermit crab Pagurus bernhardus. Animal Behaviour, 82(3), 495-501.
[ii] Koot, S., Baars, A., Hesseling, P., van den Bos, R., & Joëls, M. (2013). Time-dependent effects of corticosterone on reward-based decision-making in a rodent model of the Iowa Gambling Task. Neuropharmacology, 70, 306-315.
Dias-Ferreira, E., Sousa, J. C., Melo, I., Morgado, P., Mesquita, A. R., Cerqueira, J. J., … & Sousa, N. (2009). Chronic stress causes frontostriatal reorganization and affects decision-making. Science (New York, NY),325(5940), 621.
[iii] Schwabe, L., Wolf, O. T., & Oitzl, M. S. (2010). Memory formation under stress: quantity and quality. Neuroscience & Biobehavioral Reviews, 34(4), 584-591.
Emotional Finance 