Investments are always a gamble, instead of having the security of having your money sitting in a bank account, often gaining interest, you’re taking a risk with your money in the hopes of getting a bigger return.
Learning how to invest correctly is a key skill as it allows individuals to increase their wealth by investing in assets such as stocks, bonds, and real-estate. In order to invest successfully you need to firstly, have enough knowledge about the assets you are purchasing but most importantly, have the right personality traits.
It’s common knowledge that the higher the risk, the higher the return investment, but how would this be impacted by a crisis? The COVID-19 pandemic has sent shockwaves globally, the lockdown measures that have been put in place have caused a significant economic fallout due to industries, such as aviation and hospitality, being completely halted. Governments have tried to reduce the impact by implementing various fiscal policies but they can’t do this indefinitely.
Crises are rare, by definition they are surprising, and for this reason they are likely to trigger strong emotional responses – which can have a significant effect on investments. For this reason, we decided to look into how a crisis can affect a person’s behavioural and psychological response and trigger emotions that can impact the way they invest.
In this experiment, the participants were told to place consecutive bids to obtain a financial asset that offered a positive reward; however, this also had the potential to have a large loss that could wipe out the participants amassed earnings and bankrupt them.
To monitor the participants emotions during the experiment, we used electrodermal activity (EDA). EDA is a valuable tool in physiological science as it is a biomarker of individual emotional responsiveness that can help detect, for example, anxiety. We placed electrodes on the participants’ index and middle fingers which measured their sweat. By doing this, we were able to learn how the individual was feeling at different stages of the experiment – when the decision screen was presented to participants and when the earnings were shown.
The results show that different emotions can have numerous effects on investment decisions, but the most interesting result was that, in times of a crisis, anxiety could actually protect investors. This is because those that experienced anxiety often took fewer risks, which meant they were less likely to suffer any extreme losses and bankruptcy than their less emotional counterparts.
This is a surprising result as it contradicts what we are always told, that if you take more risks when investing, you are more likely to get a higher return of investment – normally this would be the case but we are in very unusual circumstances, therefore experiencing anxiety could improve investment decisions, and end up being the reason your company survives.
In addition, the research also revealed that emotions, such as anger and fear, can also affect investment decisions. Similar to those that showed anxiety, participants who experienced fear were more likely to decrease their bids. However, those who experienced anger when investing were more likely to increase their bids because they are unable to make peace with their losses, which then promotes risk-seeking behaviours, creating a cycle.
In sum, the research reveals that an investor’s emotion can have a large and particularly complex effect on the outcome of investments, especially if we are in the middle of a crisis, such as COVID-19. A negative event can have completely different effects depending on the individual, and having emotions such as fear and anxiousness can actually be valuable for companies – something worth considering in this uncertain climate.
Link to research paper: ftp://ftp.gate.cnrs.fr/RePEc/2020/2016.pdf
Authors:
Brice Corgnet, Professor, emlyon business school
Camille Cornand, Research Director, CNRS
Nobuyuki Hanaki, Professor, Osaka University
