[MUSIC] In the previous video, we saw how behavioral studies and findings can help us understand financial markets and individual transactions. In this video, we will take this idea one step further by arguing that looking at the brain may provide even more insights into investor behaviors. For this we will take a closer look at what happens in the human brain when we make financial decisions. The reason we think that this is relevant is because every action we take, any decision we make is ultimately generated by our brain. And this brain has evolved for thousands of years throughout which we've we're doing a lot of things, none of which was trading in financial markets. So our brains are likely optimized for a very different problem. So it shouldn't come as a surprise that we make so many errors when we make financial decisions. Let's begin with asking a very simple question. With all this talk about expected returns and risks, how does the brain process these quantities? Is there a financial center in the brain that explicitly processes expected rewards and risks? Now the way we do this is we actually record people's brain activity. And one way to do this is by using something that's called FMI, functional magnetic resonance imaging. So you may know an MRI machine from the hospital where doctors use it to take a picture of your brain. But scientists also use these machines to actually record brain activity. So what we do is we put people in an MRI machine and we let them play gambles with real money. So they experience risks, they experience gains, they experience losses. And we ask which areas of the brain throughout this are more active. So which areas of the brain respond to risks or high gains or high losses? So the next question is are these regions special in any way? Are they the financial center of our brain? The answer, not surprisingly is no. These regions do more than just process financial products. So let's take a look at this region right here. It is called the ventral striatum. And it's strongly activated when we anticipate large gains or when we receive large gains. But it's also strongly activated when we receive other forms of rewards such as food, drink, music, sex, and drugs, basically anything related to reward. In particular, things related to emotional and social rewards as well. And something similar is true when we look at the regions that process risks. They also respond to pain, disgust, empathy, other negative emotions usually in social and emotional contexts. So what we have learned is that there is no financial center in the brain. But when the brain processes expected returns and risks it does so in regions that also process other things, in particular emotions and that does explain why when we try to make rational decisions, we are often unable to do so because other things are interfering such as emotions and feelings. More importantly, if you were following one of the earlier MOOCs, you may remember our discussion on general principles of the brain, one of which was that the brain is constantly trying to make predictions and fill in information that is not actually there. And that is another aspect that really hinders our ability to make rational decisions. Our brain is constantly trying to uncover patterns even if there are none. And this is the reason why we often think we see a trend when in fact, the only, we only see random fluctuations that appear to be a trend. And when you buy into this supposed trend, you can end up losing a lot of money. And looking at brain activity helps us understand what's going on in these situations and it helps us understand what drives our decisions. Finally, also not surprisingly, when we continue to look at these brain regions, for instance the region that processes risk, we see that the strengths with which this region responds to risk depends highly on your own tolerance to risk. So when you're highly risk tolerant, this region may not become very active when you're experiencing risk. But when you're really risk averse, this region may be a lot more active. So in summary, the brain does not have a unique financial decision-making center. It processes financial returns and risk in the same way as other returns in risk and as a result, it consequently integrates our financial decisions with other things that may be irrelevant to the problem at hand. As a result of that by studying these phenomena, we can better understand an investor's decision and help her improve her decision-making in the future. So you may ask now, can I actually improve investments decisions with this? And at this point, probably not so much. What it primarily tell us is that you, or better your brain, make a lot of assumptions about financial markets, many of which are wrong and many of which you may even be unaware of. We learned that your brain can trick you into believing that you have information that is not actually there. Nonetheless, both from a scientific and a practical point of view, this new field of neuro finance has already provided us with many useful insights about the investor's brain and behavior. And while we many not yet understand its full potential, it promises to provide us with many more such insights as we continue this research. If you're interested in learning more about this type of research and its implications, you can go online and search for the terms neuro finance and neuroeconomics and explore. But remember that these are new areas of research and everything you read should be evaluated carefully and be taken with a grain of salt. And this concludes our brief excursion into the world of neuro finance. I hope you enjoyed these videos. [MUSIC]