The Amygdala is a part of the brain that is shaped like a nut - an almond; in fact its name derives from the Greek for almond.
Poets, singers and Valentine card sellers may try to tell us that the heart is the seat of emotions, but scientists know that in fact it is the Amygdala. However,since Frank Sinatra would have not gone far crooning "Young at Amygdala", we can leave the hearts to dominate the charts.
Amygdalae (yes there are two of them, one in each hemisphere of the brain) are tiny and situated deep in the brain. They are a sort of emotional controller. Faced with a shark or poisonous spider, the Amygdala screams 'run' and sends messages to our legs to get as far away as possible. Evolution has ensured that those ancestors who did not react quickly enough to a sabre-toothed tiger tended to end up as the tiger's tea, leaving us cowardly custards to inherit the earth, or at least Wall Street.
Doctors have known for over one hundred years that damage to the part of the brain that contains the Amygdala causes a person to exhibit changed emotional reactions, including loss of fear. And recent advances in Magnetic Resonance Imaging (MRI) technology have allowed neuro-biologists to watch how the brain reacts to emotional stimuli and to study differences in emotions between healthy and damaged brains.
What has this to do with risk management?
A study*, reported in this month's Scientific American, examined the risk taking attitudes of two subjects who had experienced damage to their Amygdala. The researchers found that, compared to a healthy control group, the subjects experienced reduced 'loss aversion', even if they fully understood the risks and losses involved. In lay terms they had lost the fear of losing money. The researchers suggested that the Amygdala might control "a very general biological mechanism for inhibiting risky behaviour when outcomes are potentially negative".
In financial markets we would definitely want to discourage such irrational behaviour? We don't want bad Amygdalae!
On the subject of nuts, the Amygdala has been found to be affected, not only by lesions (e.g. bangs on the head) but also by hormones, in particular Testosterone. The relationship between sex and risk taking has been documented before** and bad risk taking decisions, under the influence of sex hormones have been detected using MRI technology. Just to complete the nasty picture, the Amygdala has been found to play a role in, and be affected by, severe alcoholism. When good, the Amygdala is good, but when bad, very bad!
Could the Global Financial Crisis have been caused by damage to the industry's Amygdalae?
Before the GFC, it certainly looked like Wall Street had lost any fear of making losses. Just pile on the bad securities, just load up on the risks and if we lose a bucket load of money - what the hell, get the adrenalin rush!
Now I am not implying that Wall Street is full of sex-mad, alcoholic, brain damaged, risk seeking, gamblers, but it does look like that MRI, rather than MBS, might be useful on Wall Street.
It would be quite a jump to extrapolate the findings of a study on two subjects to a whole industry, but could it be that, in the run up to the GFC, Wall Street, like a bunch of Salem Witches, was afflicted by a bout of hysterically induced 'risk bulimia', with wild swings in risk appetite, repeatedly ingesting vast amounts of risk before puking it out again over the financial system?
(Semi)-seriously there might be a reason.
Doctors have found that monkeys with radio frequency lesions of the Amygdala suffer severe emotional problems. Now as most financial traders have more telephone and video technology on the desk that NASA had on the first moon landing they are bombarded continually by multiple radio frequencies. Could Reuters and Bloomberg be responsible for the GFC?
Until the problem is researched, I suggest that managers might want to abandon the kindergarten cacophony of the modern trading floor and return to a quieter form of work, such as a library or a monastic cloister.
Of course communication is essential to modern finance and we could return to an ancient remedy - pigeon post?
Not only would this generate new much-needed employment in the financial sector but with millions of pigeons, Wall Street would be able to experience, like the rest of us, what it feels like to have financial excrement dumped on them from a great height.
Regulators should be demanding that traders are hooked up permanently to MRI while contemplating the warnings of Oscar Wilde on the subject of emotional risk taking - "The advantage of the emotions is that they lead us astray"
* De Martino B., Camerer C.F, & Adolphs R 2010 "Amygdala damage eliminates monetary loss aversion"
Proceedings of the National Academy of Science.
** Coates, J. M. & Herbert, J. 2008 "Endogenous steroids and financial risk taking on a London trading floor."
Proceedings of the National Academy of Science.