Attention Please

Cary Frydman shows how neuroscience can influence economic policy

October 24, 2019

When choosing whether to buy or sell a stock, the brain can process only a limited amount of available information. The investor’s attention acts as a “spotlight” on financial information, and those pieces of info in the spotlight are weighed more heavily in the trading decision. At USC Marshall, this topic has caught the attention of a group of behavioral researchers. 

Neurofinance combines knowledge from neuroscience and psychology to better understand constraints on economic decisions. Associate Professor of Finance and Business Economics Cary Frydman has been at the forefront of this field of study since it emerged in the past 15 years.

Frydman recently won a five-year, $400,000 CAREER Award from the National Science Foundation to fund his research in neurofinance. Frydman, along with professors Kristin Diehl, Dinesh Puranam, and Sha Yang in the Department of Marketing, and support from an iORB grant, helped build one of the most advanced eye-tracking labs at a business school in the United States. It is available to all Marshall scholars interested in behavioral research.

“This research has direct application. Understanding the brain’s processes provides economists with valuable insights into the drivers of economic activity.”—Cary Frydman, Associate Professor of Finance and Business Economics

Frydman also created the first classes in neurofinance ever offered at Marshall. This autumn, he began teaching courses for both advanced undergraduates and doctoral students, and the response has been overwhelmingly positive.

“Not many other places are teaching this,” Frydman said. “It’s a new field, and I’m grateful Marshall has been willing to take the risk to support it.” The classes are perpetually filled with enthusiastic discussion, and students present their own ideas on how to leverage psychology to improve financial-decision-making.

The Nascent Field

Frydman was introduced to neurofinance as a graduate student at the California Institute of Technology. There, economists were just beginning to tap neuroscience as a way to gain insight into the computations made by the brain during economic decisions.

“The key was developing a common language between the neuroscientists and the economists.” Frydman says, “Caltech offered a unique set of classes that allowed the neuroeconomics dialogue to flourish across traditional academic boundaries.”

Frydman joined the faculty at Marshall in 2012 and two years later published a paper that provided the first example of how neural evidence can be used to test economic models of decision making. He and his co-authors from Caltech and Yale were able to characterize the brain computations behind financial decisions, and to understand how these map to behavior.

“This research has direct application,” Frydman said. “Understanding the brain’s processes provides economists with valuable insights into the drivers of economic activity.”

Brain Waves

Frydman said using neural data to test an economic model is still an unusual exercise in the field of economics, which is one reason his new eye-trackers bring distinctive value to Marshall. He’s now using them in a new project tracking attention and testing ways to get attention. “If you can manipulate attention,” he said, “you can manipulate behavior.”

The study focuses on risk. “We want to understand why the same person can be risk averse in some environments, and risk seeking in others,” Frydman said. “Why would someone who buys insurance turn around and gamble on a lottery ticket? Maybe because their perception of risk changes.”

In a related experiment with Antonio Rangel (Caltech), Frydman examined whether manipulating the salience of a stock’s purchase price could reduce a well-known bias called the “disposition effect.”

In their experiment, half of the subjects traded stocks when the purchase price was prominently shown. The other half of subjects were not shown the purchase price when they traded. Frydman and Rangel found that this small change in information display substantially reduced the trading bias.

Frydman has also shown that these attention effects are not confined to laboratory settings, but they also extend into high-stakes trading environments. In a forthcoming paper in the Journal of Finance (“The Impact of Salience on Investor Behavior: Evidence From a Natural Experiment,”) Frydman and Baolian Wang of the University of Florida use account level information from 15,000 online investors in China to show that the salience of information about past returns affects individual trading decisions.

Frydman said this result adds to the increasing evidence for the power of nudging attention to affect behavior. “We’re finding ways to improve financial decisions,” he said. The basic principles that Frydman and his co-authors have been studying in the lab seem to extend into real-world markets. “This can provide guidance for balanced government regulation.”

Student Interest

Frydman’s students are excited about this potential. “We read a lot of engaging empirical research about neuroscience and psychology and how these subjects can help explain an individual's decision making processes,” said undergraduate Caden Sheetz “It is so interesting to learn about biases and how they relate to everyday decisions from taking risks to trading stocks.”

According to junior, Cameron Harbilas, “The most interesting part for me is when we get into the physical makeup of the brain and try to understand the processes that cause humans to behave irrationally, make mistakes and exhibit biases—neuroeconomics,” he said. “If we can understand the process, then we will be able to predict with much more accuracy how the market will behave, and decisions people will make.”

In addition to the NSF, Frydman’s research is supported by a grant from the USC Marshall Institute for Outlier Business Research (iORB).