Anxious Investors Are Less Likely to Go Bankrupt
New research in physiological science has called the conventional wisdom of successful investor behaviours into question.
Finance Monthly hears from Brice Corgnet, Professor at emlyon business school; Camille Cornand, Research Director at CNRS; and Nobuyuki Hanaki, Professor at Osaka University, on the results of their behavioural study and what they might mean for traders.
The COVID-19 pandemic has created unprecedented times. The lockdown measures that have been put in place have shut down schools, reduced socialisation to almost zero, and halted or hindered virtually all industries.
There has been a significant economic fallout from the pandemic, with job losses and bankruptcies occurring on a daily basis. Governments globally have been implementing various fiscal policies in an attempt to control the fallout, but they can’t do this indefinitely.
Even though events like the current pandemic are rare, they have a major impact as they are by definition surprising – meaning that they are highly likely to trigger a strong emotional response, which can have a significant impact on investments. For this reason, we decided to look into individuals’ behavioural and psychological response to extreme events and how these emotions can affect the way that they invest.
For this experiment, the participants were tasked with placing successive bids to acquire a financial asset that offered a positive reward, which also had the potential to have a large loss that could wipe out the participants accumulated earnings and bankrupt them.
Even though events like the current pandemic are rare, they have a major impact as they are by definition surprising – meaning that they are highly likely to trigger a strong emotional response, which can have a significant impact on investments.
During the experiment, the participants’ emotions were monitored by electrodermal activity (EDA). We placed electrodes on the participants’ index and middle fingers which measured their sweat. By doing this, we were able to learn how the individual was feeling at different stages of the experiment – when the decision screen was made and when the earnings were shown.
EDA is a valuable tool in physiological science as it is a biomarker of individual emotional responsiveness that can help detect, for example, anxiety.
The results show that different emotions can have various effects on investment decisions, but the most interesting result that we found was that, in times of uncertainty, anxiety could actually protect investors from extreme events. This is because investors who exhibit anxiety tend to take on fewer risks, which then means they are less likely to suffer extreme losses and bankruptcy than their less emotional counterparts.
Many people will find it surprising that being anxious could improve investment decisions as this is a complete contrast to what we are usually told. Normally, those that are more likely to take risks when investing are more likely to be successful. But we are in very unusual circumstances where experiencing anxiety when investing could be what saves your company.
Furthermore, the research revealed that emotions, such as anger and fear, can also affect investment decisions. Those who showed fear were more likely to decrease their bids, similar to those that are anxious. However, those who get angry when investing are more likely to increase their bids because they have an inability to make peace with their losses, which then promotes risk-seeking behaviours, creating a cycle.
The research highlights that the effect of emotions on financial decisions is particularly complex, since a negative event like COVID-19 can have completely different effects depending on the individual. But in our current circumstances, having emotions like fear and anxiousness can actually be beneficial for companies – something worth considering in this unstable climate.