Electronic copy available at: http://ssrn.com/abstract=1943325
Fear, Greed, and Financial Crises:A Cognitive Neurosciences Perspective
Andrew W. Lo
First Draft: August 28, 2011Latest Revison: October 12, 2011
Historical accounts of ﬁnancial crises suggest that fear and greed are the common denom-inators of these disruptive events: periods of unchecked greed eventually lead to excessiveleverage and unsustainable asset-price levels, and the inevitable collapse results in unbridledfear, which must subside before any recovery is possible. The cognitive neurosciences mayprovide some new insights into this boom/bust pattern through a deeper understanding of the dynamics of emotion and human behavior. In this chapter, I describe some recent re-search from the neurosciences literature on fear and reward learning, mirror neurons, theoryof mind, and the link between emotion and rational behavior. By exploring the neuroscien-tiﬁc basis of cognition and behavior, we may be able to identify more fundamental driversof ﬁnancial crises, and improve our models and methods for dealing with them.
Prepared for J.P. Fouque and J. Langsam, eds.,
Handbook on Systemic Risk
, Cambridge UniversityPress. Research support from the MIT Laboratory for Financial Engineering is gratefully acknowledged. Ithank Jayna Cummings and Hersh Shefrin for helpful comments and discussion. The views and opinionsexpressed in this article are those of the author only and do not necessarily represent the views and opinionsof AlphaSimplex Group, MIT, any of their aﬃliates or employees, or any of the individuals acknowledgedabove.
Harris & Harris Group Professor, MIT Sloan School of Management, and Chief Investment Strategist,AlphaSimplex Group, LLC. Please direct all correspondence to: Andrew W. Lo, MIT Sloan School of Management, 100 Main Street, E62–618, Cambridge, MA 02142.