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Blame Biology For Stock Market Bubbles

Daily Ticker

The next time there is a bubble in stocks, or the housing market, or in any asset class really, you can blame your neighbor. And your colleagues at work. Maybe even your hairdresser. California Institute of Technology researchers employed neuroscience to explain why certain assets are driven to exorbitant prices. What they found: individuals are more likely to make irrational decisions when trying to determine how others will behave. Blame biology.

Brain scans of study participants who engaged in mock trading showed a higher flow of blood to the brain’s frontal cortex, an area that is responsible for processing value judgments and social cues.

Study co-author Benedetto De Martino sums up the experiment this way:

“In a bubble situation, people start to see the market as a strategic opponent and shift the brain processes they’re using to make financial decisions,” he said. “They start trying to imagine how the other traders will behave and this leads them to modify their judgment of how valuable the asset is. They become less driven by explicit information, like actual prices, and more focused on how they imagine the market will change.”

We finally have empirical evidence for what we already knew about market bubbles, says Yahoo Finance senior columnist Mike Santoli in the attached clip.

The word “bubble” has been increasingly used to describe U.S. markets in recent weeks as stocks soar to record highs. Let’s not get too excited yet, says Santoli. Yes, financial markets have outperformed the real economy, but stocks still have a long way to go before reaching bubble territory, he argues.

Related: Are Stock Bulls Banking on a Bubbly Endgame?

“We don’t have a lot of public excitement about stocks despite the fact that they’re at all time highs – that’s what you usually see in a bubble,” he says. “Retail investors are not throwing money at stocks.”

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