The Psychophysiology of Real-Time Financial Risk Processing

Abstract

A longstanding controversy in economics and finance is whether financial markets are governed by rational forces or by emotional responses. We study the importance of emotion in the decisionmaking process of professional securities traders by measuring their physiological characteristics, e.g., skin conductance, blood volume pulse, etc., during live trading sessions while simultaneously capturing real-time prices from which market events can be detected. In a sample of 10 traders, we find statistically significant differences in mean electrodermal responses during transient market events relative to no-event control periods, and statistically significant mean changes in cardiovascular variables during periods of heightened market volatility relative to normal-volatility control periods. We also observe significant differences in these physiological response across the 10 traders which may be systematically related to the traders' levels of experience.

Keywords: Behavioral Finance, Market Efficiency, Market Rationality, Psychology, Psychophysiology

JEL Classification: G10, G14, C91, C93