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vix

In 1802, in a letter to then Secretary of the Treasury, Albert Gallatin, Thomas Jefferson warned that, “If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.” (source)  Although the US now does have a central government bank, Jefferson’s warning still chillingly echoes through our current crisis as we teeter on this very brink.

The reasons why the US financial system lies stricken now (not to mention many times before) are complex for sure, but for a neuroscience & genetics buff like myself, its fun to consider the underlying mechanisms of human biology and behavior within a macroeconomic framework.  What role for the brain and human nature? How does our understanding of human social and emotional behavior reconcile with the premise of so-called “rational” behavior of investors and consumers in a marketplace? Can we regulate and design a debacle-proof economic system that accounts for human social and emotional influences on otherwise rational behavior? Luckily, if you are interested in these questions, you need only to pick up a copy of “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism” by George Akerlof and Robert Shiller, who cover this very topic in great detail and provide a broad framework for neuropsychological research to inform macroeconomic policy.  A lofty and distant goal indeed, but perhaps the only way forward from such spectacular wreckage of the current system.

One such aspect of so-called “animal  spirits” could be, for example – fear – which has been blamed many times for financial panics and is covered in great measure by Akerlof and Shiller.  During the depths of the great depression, FDR famously tried to shake people loose from their animal spirits by suggesting “Only Thing We Have to Fear Is Fear Itself” (listen to the audio).   As another example, consider the chart at the top of the post – a 5yr trace of the VIX an index of volatility in the price of stock options over time.  In a bull or a bear market, when there are clear economic signals that stock prices should rise or fall, the VIX is rather low – since people feel relatively certain about the overall direction of the market.  Note however, what happened in the fall of 2008, when the heady days of the housing boom ended and our current crisis began – the VIX rockets toward 100% volatility – indicating rather dramatic swings in future earnings estimates and hence, tremendous uncertainty about the future direction of the market.  Indeed, for high flying investors (who may reside in tall buildings with windows that open) the VIX is sometimes referred to as the fear index.

What – in terms of brain mechanisms – might underlie such fear – which seems to stem from the uncertainty of whether things will get better or worse?  What do we know about how humans react to uncertainty and how humans process uncertainty?  What brain systems and mechanisms are at play here? One recent report that uses genetic variation as a tool to peer into such brain mechanisms suggests that dopamine signaling modulates different brain areas and our propensity to respond in conditions of low and high uncertainty.

In their article, “Prefrontal and striatal dopaminergic genes predict individual differences in exploration and exploitation“, [doi:10.1038/nn.2342] Michael Frank and colleagues examine individual differences in a so-called exploration/exploitation dilemma.  In their ‘‘temporal utility integration task’’, individuals could maximize their rewards by pressing “stop” on a rotating dial which can offer greater rewards when individuals press faster, or when individuals learn to withold and wait longer, and, in a third condition when rewards are uncertain.  The authors liken the paradigm to a common life dilemma when there are clear rewards to exploiting something you know well (like the restaurant around the corner), but, however, there may be more rewards obtained by exploring the unknown (restaurants on the other side of town).  In the case of the VIX and its massive rise on the eve of our nations financial calamity, investors were forced to switch from an exploitation strategy (buy housing-related securities!!!) to an exploration strategy (oh shit, what to do?!!).

The neurobiological model hypothesized by Frank and colleagues predicts that the striatum will be important for exploitation strategies and find supporting data in gene associations with the striatally-enriched DARPP-32 gene (a marker for dopamine D1-dependent signalling) and DRD2 for the propensity to respond faster and slower, respectively, in the exploitative conditions (rs907094 & rs1800496).  For the exploratory conditions, the team found an association with the COMT gene which is well-known to modulate neural function in the prefrontal cortex (rs4680). Thus, in my (admittedly loose) analogy, I can imagine investors relying on their striata during the housing boom years and then having to rely more on their prefrontal cortices suddenly in the fall of 2008 when it was no longer clear how to maximize investment rewards.  Egregious bailouts were not yet an option!

Click here and here to read more breakthrough neuroeconomics & genetic research from Michael Frank and colleagues.  Here and here for more on Shiller and Keynes.

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