Brain Activity Follow Up of Stock Market Financial Variables

Armando F. Rocha1, João Vieito2 and Fábio T. Rocha1

1
RANI – Research on Artificial and Natural Intelligence
2
Polytechnic Institute of Viana doCastelo, Portugal
Abstract

Efficiency Market hypothesis assume that all investors reason in the same way to make
their financial decisions. In contrast, Neurosciences have provided strong evidences that
cognitive diversity is the hallmark of human intelligence. Neurofinances has shown that
volunteers learned different profitable financial decision-making strategies depending
on the kind of market they begun to trade. Here, we decide to further explore this
hypothesis by studying a possible correlation between brain activity and the financial
variables in a stock market game and to test if this correlation differ between
experimental groups that trade in different market conditions. Present results show that
volunteers had different perceptions of the studied financial variables depending if they
initially traded in a bear or a bull market. Our findings are consistent with the
hypothesis that different neural circuits were learned to monitor the different financial
variables studied here, depending on market conditions.

Keywords: Neurofinances, Decision Making, Perception, EEG, Brain Mapping,

Cognition, Learning.
Introduction

Efficiency Market hypothesis (EMH) has become one of the most prominent
theories in finance (Fama, 1970). In essence, this theory argues that agents have rational
expectations and want to maximize their utility, and affirms that no investor may
outperform the market because traded assets already include all past publicly available
information about market. EMH claims that when new information is made available,
some investors overcorrect the prices; others under correct it so that overall market
reaction is random such that no one may take financial advantages. Criticism to this
theory emerges essentially because “bubbles” or crises cannot be anticipated (Ball,
2009; Malkiel, 1989, 2003, Statman, 2011). Although such criticisms were made after
crises 20 years away from each other (Ball, 2009; Malkiel, 1989, 2003) authors
concluded that it was premature to abandon EMH (Statman, 2011). Perhaps the core
problem in EMH is to assume that all investors reason in the same way to make their
financial decisions.
In one of the first studies in Neurofinances, Gehring and Willoghbt (2002) used
the electroencephalogram (EEG) to analyze brain activity associated with financial
decision- making and found that a negative-polarity event-related brain potential,
probably generated by a medial-frontal region in or near the anterior cingulated cortex,
was greater in amplitude when financial choice resulted in loss than when it resulted in
gain. Neuroeconomics and Neurofinances are new multidisciplinary fields of science
that propose to use knowledge, theories and techniques from Finances, economics and
Neurosciences to study financial decision making. It proposes that investors are not
always rational in their financial decisions (e.g., Kuhnen and Knuston, 2005;
Willoughby, 2002; Huettel et al. 2006; McClure et al. 2004); that is, they do not always
try to maximize their profits (Sanfey et al. 2003).
Vieito et al (2013) recorded the EEG while volunteers played a stock market
game (see Figure 1) in two different market conditions during two different
experimental sessions. Half volunteers (G1) made 50 trading decisions on market M1 (a
bull market) in session 1 (S1) and another 50 trading decisions on market M2 (a bear
market) in session 2 (S2). The other volunteers (G2) traded initially on market M2 and
on market M1 during session 2. Both game results and EEG analysis clearly show that
volunteers learned different profitable financial decision-making strategies, which
depend on the kind of market (M1 or M2) they initially traded on session S1, and kept
using these strategies during the second trading session S2 when they operated in a
reversed markets (M2 or M1). Principal Component Analysis revealed that 3 factors
accounted for more than 68% of data covariance of EEG activity associated with
financial decision-making. It may be assumed, therefore, that financial decision- making
is associated with 3 different patterns (Pi) of brain activity. The analysis of Pearson’s
correlation coefficients showed that these patterns Pi were similar when the different
experimental sessions S1 and S2 were taking into consideration for both G1 and G2. In
contrast, the same type of analysis showed that brain activity patterns exhibited by G1
were different from those exhibited by G2. These results showed that G1 and G2
enrolled different neural circuits to support their financial decision-making, and the
authors concluded that G1 and G2 learned different trading strategies supported by these
different neural circuits, depending on the type of market (M1 or M2) they initially
traded. Their results clearly contradict some EMH assumptions.
Both experimental groups G1 and G2 maintained an almost invariant portfolio
value (invested value Inv) during each trading session and experienced positive
revenues (RE) during both trading sessions, such that their final balance ( FB = Inv +
RE ) was also positive in both M1 and M2. The values of each of these financial
variables were available for the individuals for each trading decision. Perhaps this was
the reason because they continued to use the same circuits in the second trading session
when market’s conditions reversed.
Here, we decide to explore this hypothesis by studying a possible correlation
between the recorded brain activity and the financial variables Inv, RE and Fb. For this
purpose, we computed the amount of information H (ei ) provided by each recording
electrodes (Rocha et al, 2010) about the recorded brain activity and used linear
regression analysis between H (ei ) and Inv, RE and Fb to study how G1 and G2
monitored these financial variables.
 Methods

The investigation was done based on a sample composed by 40 undergraduate

students of the School of Business Studies from Polytechnic Institute of Viana do
Castelo, Portugal. The sample is composed by 20 women and 20 men from age 20 to 45
years. This will guarantee that students are homogenous in term of financial knowledge.

Figure 1 – Stock trading game and Market evolution.

I– the relative stock price; Var –difference between actual and previous relative
stock price, Price – actual real stock price, Qt – quantity of owned stocks, Value –
total invested in each stock; T-Qt – proposed number of stocks to trade; T-Price-
Valor – proposed transaction price; S – selling option; B – buying option; OK – to
finish proposal. Inv – actual total investment; RE – revenue (gain or loss);
Fb=Inv+RE and A – available money for new buying. Stock market relative index:
in green, the evolution oin Market 1 and in red, the evolution in Market 2.
Figure 2 - Location and code of the 20 electrodes used to record the EEG and
location of some sources (sets o neurons) of the electric currents that contribute to
the electric field recorded by each electrode. Correlation analysis is used to
calculate the amount of information (entropy) provided by each electrodes about
EEG sources. Regression Analysis is used to generate the Regression Mappings
associating a financial variable with electrode entropy ( H (ei ) ).
 Each volunteer played the investment game show in Figure 1, with a portfolio
composed by 200 stocks of 7 different companies trade at the Portuguese Sock Market
(Banif, Portugal Telecom, Energias de Portugal; Banco Comercial Portugues; BRISA,
Cimentos de Portugal and Futebol Clube do Porto), while their EEG were redorded.
Volunteers made a total of 100 investment decisions or tradings (50 decisions in
series 1 (S1) and 50 decisions in series 2 (S2)), being able to buy, sell or hold these
stocks. Information about the actual Portfolio value or total amount invested (Inv), the
actual revenue (RE) and Financial Balance ( FB= Inv + RE ) were provided for each
trading. EEG was recorded during the entire experiment.
Volunteers traded in two different markets: market M1 is a bull market with
stock prices steadily increasing and M2 is a bear market with high stock price volatility
that resulted into a almost stable market index (Figure 1). Half volunteers (G1) made 50
trading decisions on market M1 in session 1 and another 50 trading decisions on market
M2 in session 2. The other volunteers (G2) traded initially on market M2 and on market
M1 during session 2. Relative stock prices were used to calculate stock price, by
multiplying it by the value of the stocks at Portuguese Stock Market on February, 1,
2012. Therefore, M1 and M1 portfolios have different values, but volunteers were
restricted to 50.000 euros to trade on each market. Is also important to say that none of
the volunteer had any information about the way each of the stock will behave across
the investment simulation process.
The electric (temporal electric field variation) activity recorded by a set of
electrodes ei (EEG) is a weighted sum of the electric currents (sources s l ) generated by
neurons located of different cortical areas (Figure 2). Correlation analysis allows the
quantification of information ( H (ei ) ) provided by each electrode ei about the electric

sources si . Linear regression analysis was used to quantify the possible relations
between and the financial variables Inv, RE and Fb according to the model:

V = α + β H (e1 ) + ... + β H (e 20 ) , V = Inv or RE or Fb

1 20

The values of the angular coefficients H (ei ) for the calculated linear regression were
color-coded as described in Appendix 1 to build the regression.
Results

Figure 3 shows the Regression mappings correlating H (ei ) and Inv (Porfolio
Value) and Inv evolution during trading in sessions S1 and S2.

Figure 3 – Regression mappings for the relation between H (ei ) and Portfolio (or
invested) value (INV) for experimental groups G1 and G2. INV evolution during
the first (S1) and second (S2) trading sessions and markets M1 and M2 are also
displayed. See Appendix I for the color encoding procedure used to generate the
Regression mappings. t is the trading order.

____
G1 and G2 maintained portfolios mean values ( PF ) that tended to be similar in
____
market M1 and were different in M2 (See Table 1). PF values were very similar to the
values PFo of the portfolios initially allocated for both groups in both markets. This
means that Sell/Buy ratio was not disproportionally different from 1 for either G1 or G2
and M1 or M2. However, Inv temporal evolution was quite different for both
experimental groups and the two markets. It may be assumed that although G1 and G2
trade on the same markets, the order they experienced the different market conditions
was very influential on the strategy they used to trade in M1 and M2. It must be
remembered that Vieito et al (2013) reported that both experimental group maintained
the same strategy to trade on the different markets, although they used trading
strategies.
Inv regression mappings were different when G1 and G2 are compared (Figure
1) as expected if these groups used different trading strategies. Calculated H (ei ) for
electrodes C3, CZ, F7, O2, OZ, P3 and T6 in case of G1 were positively correlated with
Inv, whereas in case of G2, Inv positively correlated with H (ei ) calculated for

electrodes CZ, F4, F7, F8, FP1, OZ and T3. In addition, H (ei ) calculated for electrodes
F4, F8, T3 and T5 in case of G1 were negatively correlated with Inv, whereas in case of
G2, Inv negatively correlated with H (ei ) calculated for electrodes FZ, P4, T4 and T5.
These findings are in agreement with results reported by Vieito et al (2013) that
Principal Component Analysis (PCA) disclosed 3 patterns of H (ei ) covariation that
differed for G1 and G2.

Table 1 – Financial variables mean values

G1 G2 p
Inv
M1 31099 30117 0,05
M2 39122 41191 0
RE
M1 3691 7135 0
M2 10374 5704 0
Fb
M1 34791 37252 0
M2 49496 46896 0

Figure 4 shows the Regression mappings correlating H (ei ) and RE (Revenue

Value) and RE evolution during trading in sessions S1 and S2.
Figure 4 – Regression mappings for the relation between H (ei ) and revenue value
(Re) for experimental groups G1 and G2. RE evolution during the first (S1) and
second (S2) trading sessions are also displayed. Linear equations describe the
statistics for the linear relation between Re and trading session number. See
Appendix I for the color encoding procedure used to generate the Regression
mappings. t is the trading order.

The angular coefficient for the linear relation between Returns (RE) and trading
order (t) was 216 for S1 and 286 for S2 in case of experimental group G2 and was 155
____
for S1 and 151 for S2 in case of experimental group G1. In addition, the mean RE return
values were different for both experimental groups and markets (Table 1). G1
____ ____
maintained a higher RE than G2 in M2 and G2 maintained a higher RE than G1 in M1.
____
These results show the both experimental groups experienced RE s that where larger in
session S2 compared to S1, what may indicate that both group improved their strategies
from S1 to S2.
H (ei ) calculated for electrodes F3, F8, T3 and T5 in case of G1 were positively

correlated with RE, whereas in case of G2, RE positively correlated with H (ei )
calculated for electrodes C3, F3, FP2, FZ, O1, O2, T4 and T5. In
addition, H (ei ) calculated for electrodes C3, F7, FZ, O2, P3 and T6 in case of G1 were
negatively correlated with RE, whereas in case of G2, RE negatively correlated
with H (ei ) calculated for electrodes CZ, F4, F7, FP1, OZ, P3 and T3. In other words,
there are more electrodes positively correlated with RE in case of G2 in comparison to
G1, but the return rate was greater for G2 in comparison to G1. These findings also
corroborate the proposal that G1 and G2 learned different trading strategies because they
initially traded in different markets.
Figure 5 shows the Regression mappings correlating H (ei ) and Fb (Financial
Balance) and Fb evolution during trading in sessions S1 and S2.
The angular coefficient for the linear relation between Financial Balance (Fb)
and trading order (t) was 230 for S1 and 141 for S2 in case of experimental group G2 and
was 178 for S1 and 114 for S2 in case of experimental group G1. In addition, the
____
mean Fb financial balance values were different for both experimental groups and
____
markets (Table 1). G1 obtained a higher Fb than G2 in M2 and G2 maintained a higher
____
Fb than G1 in M1. These results are consequence from the fact that Inv did not differ
____
to much for each experimental group and market, but RE were different when
experimental groups and the different markets are compared.
H (ei ) calculated for C4, CZ, F3, OZ and T4 in case of G1 were positively

correlated with RE, whereas in case of G2, RE positively correlated with H (ei )
calculated for electrodes C3, F3, F8, FP2, O1, O2, OZ, P4, T3 and T6. In
addition, H (ei ) calculated for electrodes F4, FZ, O1, O2 and T3 in case of G1 were
negatively correlated with RE, whereas in case of G2, RE negatively correlated
with H (ei ) calculated for electrodes FZ, P3 and T4. In other words, there are more
electrodes positively correlated with Fb in case of G2 in comparison to G1, but the FB
rate was greater for G2 in comparison to G1.
Figure 5 – Regression mappings for the relation between H (ei ) and Financial
Balance (Fb) for experimental groups G1 and G2. Fb evolution during the first (S1)
and second (S2) trading sessions are also displayed. Linear equations describe the
statistics for the linear relation between Fb and trading session number. See
Appendix I for the color encoding procedure used to generate the Regression
mappings. t is the trading order.

Discussion

The linear regression analysis shows that financial variables correlate with the
EEG activity associated with neurons widely distributed over cortex, because the
calculated β i was statistically significant for electrodes located over the frontal, central,
temporal, parietal and occiptal cortices for all the studied linear regressions. However,
the β i s calculated for G1 and G2 have, in general, opposite signals, meaning that
H (ei ) correlates with the financial variables in opposite ways in each experimental
group. The findings show that volunteers had different perceptions of the studied
financial variables depending if they initially traded (in session S1) in a bear (M1) or a
bull (M2) market. The market’s conditions when they started to play the financial game,
therefore, were very influential on how volunteers in each experimental group
successfully learned to play the game. It has to be remembered that Fb for both groups
was above the initial value of their portfolios in both markets.
From the above it is possible to conclude that individuals learned different
strategies to support their successful trading decision making, as proposed by Vieito et
al (2013). If this is true, then any financial theory has to into consideration the diversity
of strategies that investors may learn trading in a market that it is always dynamic, with
stock prices in continuous movement.
In addition, the present paper shows that different neural circuits were used to
monitor the different financial variables studied here. The significant β i s in the linear

regressions between H (ei ) and each of these variables were different, both when the

electrodes and β i signal were considered. Each of the studied variables provided
different types of information about how successful trading was occurring, therefore,
different neural circuits should have to be enrolled to monitor these financial variables,
as observed here.
Because G1 and G2 volunteers learned different strategies to play the game, they
are also supposed to enroll different neural circuits to monitor the variables of interest as
observed here. These variable were not taken at face value, but they were analyzed
according to the strategies in use.
Summing up, it is necessary to stress that many of the above conclusions are
supported by what the present study disclosed about the brain activity associated with
the monitoring of the studied financial variables. Therefore, the present paper also
shows how profitable may be any interdisciplinary research involving Neurosciences
and Finances.
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Appendix 1 – The EEG mapping technology

Two networked personal computers were used to record the EEG and to display

the financial games. The volunteers were allowed to take as much time as needed to

make a decision. The moment t ok volunteer t ok pressed the OK button was annotated

together with chosen type of trading (Sell, Buy or Hold), and if pertinent, also with

stock asked price (T-Price) and number of stock (T-Qt) to be trade. The EEG was

visually inspected for artifacts before its processing, and the EEG epochs associated

with a bad EEG were discarded (e.g., when eye movements could compromise the

results of regression analysis).

The linear determination coefficients ri , j between the activity recorded by each

electrode ei and that recorded by each of the other 19 electrodes e j were calculated for

EEG epochs of seconds prior to each trading decision ( t ok − 2 ). The determination

coefficient ri , j was used to select the EEG sequence to calculate the correlation

entropy h(ci ) (Foz et al., 2001; Rocha, Massad and Pereira Jr., 2004; Rocha et al.,

2005; Rocha et al., 2010 and Rocha, Rocha and Massad, 2011) as:

h(ri , j ) = − ri , j log 2 ri , j − (1 − ri , j ) log 2 (1 − ri , j ) (1)

19

∑r i, j
ri = 1
(2)
19

h(ri ) = − ri log 2 ri − (1 − ri ) log 2 (1 − ri ) (3)

 19
H (ei ) = ∑ h(ri ) − h(ri , j ) (4)
1

It may be stressed that we did not intend to assign any physiological meaning to

the entropy h(ci ) . The correlation entropy h(ci ) was assumed to be a measure of the

uncertainty about the existence of a correlation between the activity recorded by pairs of

electrodes ei , e j . The entropy h(ri , j ) is equal to 1 when ri , j = 0.5 and equal to 0 when

ri , j = 0 or ri , j = 1 . Thus, h(ri , j ) measures the uncertainty of the correlation between

the EEG activity recorded by ei , e j . The entropy h(ri ) of the mean correlation ŕi

provides more information about the covariance of the correlation between the activity

recorded by ei and all other e j . If ri , j = 0.5 for all e j , then ri = 0.5 and h(ri ) = 1 . Also,

if ri , j → 0 for some e j , ri , j → 1 for some other e j and ri , j → 0.5 for the remaining e j ,

then ri = 0.5 and h(ri ) = 1 . However, if ri , j → 1 ( ri , j → 0 ) for most of the e j , then

ri = 1 ( ri = 0 ) and h(ri ) = 0 . All other conditions imply h(ci ) → 0 . Therefore, the

actual value of H (ei ) is a measure of how much the EEG activity recorded by the

electrode ei may be associated with the task being processed by the brain.

A null hypothesis was constructed by randomly reordering the EEG channels,

i.e., the mean entropy was recomputed from a hypothetical brain obtained by randomly

shuffling the EEG recorded activity from the individuals. Next, the Z scores between

the mean entropy and the null hypotheses were computed for each of the EEG epochs

(facial evaluation – F, results satisfaction evaluation – R and attractiveness self-

evaluation – A). The mean entropy calculated for each channel was used to generate the

mean entropy brain mapping values shown in Figure 2, and the corresponding Z scores

were used to generate the Z score mapping values. The minimum Z core for all of these
calculations was 1.979, showing that the null hypotheses were rejected for all EEG

epochs.

Linear regression analysis was used to study the correlation between h(ci ) and

the financial variables Inv, RE and Fb, according to the model:

V = α + β H (e1 ) + ... + β H (e 20 ) , V = Inv or RE or Fb

1 20

(5)

The normalized values of the β i were used to build the color-coded brain

mapping images to display the results of the regression analysis. β i were normalized

and collor encoded to generate the Regression Mappings. Positive betas β i were coded

from green (normalized β i tending to 0) to dark blue (normalized bi tending to 1).

Statistically negative bi were displayed from rose (normalized bi tending to 0) to dark

red (normalized bi tending to -1), and statistically non-significant bi are shown in

orange.

Linear regression analysis becomes complicated for multivariate inferences

_
because the total possible error α is dependent on the number n of inferences

(Benjamin et al., 2001; Blakesley et al., 2009; Genovese et al., 2002; Huizenga et al.,

2007; Marroquin et al., 2011; Nandy and Cordes, 2007; Vechiato et al., 2010). For

statistical inferences supported by independent variables, the possible error is multiplied

by n because, for each inference, the risk of its being wrong is 5%. The total possible

_
error is, therefore, α = nα , which implies that the certainty of making a wrong

inference increases as the number of inferences increases. The solution is to decrease

the value of α to minimize the total possible error. Bonferroni proposed α to be 1 / n

 _
of the total admissible error α . Because the Bonferroni procedure may be too

conservative and may increase the type II error, the Holm-Bonferroni method has been

commonly used instead. However, when the independence hypothesis can be removed,

_ _
α < nα . In this condition, α may be greater than 1 / n of the total admissible error α .

As the correlation between the variables increases, the FWER calculation

_ _
as α ≤ 1 − (1 − α ) n maintains the level of possible total error at around α . We combined

stepwise regression, the Holm-Bonferroni and the FWER methods to select the most

relevant statistical inferences between the EEG activity and the volunteers’ poll

evaluations.