Stock Market Bubbles and the Near Miss Effect

This American Life had another remarkable episode a few weeks ago on blackjack (which I just got around to). As usual, there's lots of good stuff here, but two parts in particular caught my eye. The first was this work from two researchers at Southern Illinois University, Reza Habib and Mark Dixon (the second will have to wait for an upcoming post):

Sarah Koenig
In 2006, Dixon teamed up with Habib to see if they could figure out what was happening to people neurologically when they saw near misses. They scanned the brains of 22 gamblers-- 11 addicted, or what they called pathological gamblers, and 11 non-pathological gamblers-- as all these people watch near misses on slot machine displays. 

 The results surprised them. Because while both addicted and non-addicted gamblers said the near misses felt more like wins, their brains said something different. Here's Reza Habib. 

Reza Habib
What you see in the non-pathological gamblers is that the regions that are activated for losses, those same regions tend to be also activated for near misses. And so the brain, at least, processes these near misses in the same way that it processes losses in the non-pathological gamblers. In pathological gamblers, the same regions that are activated for wins are also activated for near misses.

And so these include regions such as the amygdala, which is a region involved in emotional processing, as well as parts of the brain stem which are involved in reward and dopamine function, which is part of the reward system. So the pathological gamblers, their brains, at least, are responding to these near misses in the same way that they respond to wins.

Mark Dixon
This is Mark again. And one of the effects of this, or the implications of these data, are that a pathological gambler going into the casino who's actually losing, his brain is firing like he's winning. Disturbing, isn't it.

Sarah Koenig
Yeah. It's crazy.

Mark Dixon
Oh, it's way crazy. And so you are experiencing those same sensations as a win when you're not winning.

This got me thinking about bubbles. Even in normal times, traders experience constant near-misses; they get in a bit too late or stay in a bit too long or buy a dud only to watch its nearest competitor shoot through the roof. In bubbles those near miss moments easily increase by an order of magnitude. Every time a trader talks to a friend or picks up the Wall Street Journal, he or she hears about an almost-purchased stock doubling in value.

I wonder how much of the curious behavior of markets in bubbles is driven by those traders whose brains are scoring near misses as wins? I'm sure someone's looking at this from the neuroscience side. It might also be worth factoring in when doing agent-based simulations of the market.