Why are some people more likely to expose themselves to risk than others? Why are some people completely risk-adverse? How does the average person behave in response to risk – and why?
As neuroscience tells us more about the workings of the brain, and how we make decisions, these are questions on the lips of many a business leader – especially (but certainly not limited to) those in financial and insurance marketplaces.
If we were all able to respond successfully to risk, everyone would retire with enough money and we would have fewer accidents for starters. The world would be a lot more stable place if everyone managed risk perfectly – but we all know that’s not the case.
Early risk models
Going back 70 years, the first models to look at risk behaviour were centred around the rather limited theory of ‘expected utility’: this says that people value a possible outcome by multiplying the probability that something happens by the amount they would like it to happen.
However, in the real world, this theory was found to be wanting. Subsequently, Daniel Kahneman’s creation of prospect theory helped him win a Nobel Prize. It posited that people measure outcomes relative to a reference point. However, these reference points are difficult to define and can change unpredictably.
While other models have tried to take the ‘science of risk’ forward, most fail to answer the question of how people really make choices and how they form their vision of the future. Often the rational, predictable, logical processes that economists expected were found NOT to be driving decision-making; cognitive biases and emotion play a much more important role than previously suspected.
Though these cognitive biases and range of emotional triggers are difficult to predict, neuroscience has the potential to add new layers to our understanding of decision-making and risk.
The potential of neuroscience
The world is unpredictable and uncertain. It is therefore not surprising that there are no categorical ‘rules’ that we can apply to people’s response to risk.
However, the amount of studies on the workings of the brain has grown dramatically since the use of functional magnetic imaging became more widespread. There is great potential to find out more.
For instance, in a study on rats at Stanford University, scientists discovered that a group of neurons light up when a safe option is chosen over a risky one; there is potential for these neurons to also be found in the human brain, which may uncover important information about risk avoidance.
Imagine studying stock market traders’ brains as they make decisions based upon their daily returns – what happens when they make big losses or gains? How does this change their decision-making? How does risky behaviour spread through the market – what are the social cues and biases at play? Better understanding of risk behaviour can potentially help us prevent stock market ‘bubbles’ and ‘bursts’ in the future.
Such experiments are well underway in neuroscience labs and we can expect more investigation in the near future, as the major financial players and government regulators become more interested.