WHAT happens to your body when you take risks? What happens to it when you make or lose money? Economics rarely asks these questions. It tends to view the assessment of financial risk as a purely intellectual affair, involving the calculation of asset returns, probabilities and allocation of capital. It is economics from the neck up.
But to this bloodless account of decision making, I want to add some guts. Advances in neuroscience and physiology have shown that when we take risk, we do a lot more than just think about it. We prepare for it physically.
Normally, the body of a risk-taker purrs along efficiently — after all, our bodies have been crafted for the quick reactions and gut feelings we need to survive in a brutal world. But not always. Under circumstances of outrageous success or terrifying failure, our biology can overreact; and when this happens to traders and investors, they suffer an irrational exuberance or pessimism that can destabilize financial markets and wreak havoc on the wider economy.