Financial markets typically exhibit sudden peaks and troughs. When these peaks and troughs are especially pronounced, market participants term them bubbles, booms, and busts. Anyone involved, from the brokers who execute, the analysts who scout out opportunities for marketing, to the investors who hire their services, are exposed to potentially devastating losses during these bubbles. Understanding bubbles is thus of utmost importance.

Two convergent disciplines are yielding  results. A recent collaborative study combining neuroscience and finance is a recent example.  Their basic finding is that when bubbles emerge, investors begin to bias their value judgments in an attempt to anticipate and predict what other investors will do and thereby extend the bubble. The historically ensuing troughs indicate disatrous losses of billions or more. The researchers were able to get student volunteers to participate in a mock experimental market while under observation in an fMRI (functional magnetic resonance imaging) scanner.

Specific brain regions correlated to social interactions showed higher than baseline activity during these biased lapses in judgment, potentially highlighting the neural mechanism for the disastrous losses. "People who had greater activity in this region were more likely to ride the bubble and lose money by paying more for an asset than its intrinsic worth." The implication is that with a better understanding of the mechanisms by which people make and bias their value judgments, one can build better social interventions to prevent future bubbles.

Now for the devil's advocate.

The first low hanging fruit as ever is in the techniques. fMRI has been the darling of neuroscience research these past two decades because of its ability to peer into the brain fairly unobtrusively without surgery, implants, injections, or radiation. It relies on the BOLD (blood oxygenation level dependent) contrast signifying what brain regions need more oxygen and therefore must have been especially active and consumed more. Downsides include that the signal is of rough resolution, delayed by seconds, and very faint, all of which require special statistic filtering post procesing techniques that can corrupt the signals.  An fMRI machine looks like an MRI machine. It is a huge noisy horizontal tunnel that requires subjects to remain absolutely still as if under a very long (e.g. 30 minute) exposure optical camera. Say "cheese" and smile for half an hour. While sideways. And wearing clunky earmuffs. And trying to fill out a multiple choice exam. Imagine not executing someone else's orders but trying to place hard won life savings under these conditions. Also imagine that you are a student fresh from worrying about grades, homework, and midterms, but profoundly not about the 10 year future value of present capital that could be used for home insurance, healthcare, or mortgage payments. Those are the low hanging fruits. We can skip those since the insight return on investment of time on those is rather small and too general.

The higher fruit revolve around understanding finance, neuroscience, and their practice. The keywords at the heart of this sample research are: "intrinsic worth", "social signals", and "bubbles."

Intrinsic worth refers to the textbook fundamental financial analysis focusing on calculating balance sheets, income statements, cash flow, and potential annuities in the form of coupons or dividends. Discounting all these streams to the present date using expected inflation numbers derives a fair intrinsic assayed value. Bidding more is overpaying at a premium. Bidding less is underpaying for a discount. Ideal prices should be flat lines. Next best ideal prices should be a series of plateaus following business events. The practice in reality has more complicating factors.

Briefly, financial analysis relies on an accounting foundation. Income statements and balance sheets are the purview of accounting. The first order of business in accounting and auditing is to find prior year work papers and find changes. If such papers do not exist, find similar firms and substitute. This is not being lazy, it is called precedent and is also followed in law. But it means no balance sheet is truly independent. And it means no financial assay is truly independent. The accounting term "mark to market" for instance indicates the asset value is what someone else would pay for it. Without this approach, asset prices on a balance sheet could be any dreamed up number. With this approach, asset values are socially recursive, which means they are shared dreams. This was and still is a particular quandary in the 2008 financial crisis.

Social signals resonate in the human brain's right dorsolatetal prefrontal cortex. Research indicates this region, when manifest in financial decision making under uncertainty, is responsible for risk averse behavior. Disabling this brain region as by the use of transcranial magnetic stimulation effectively replicating a temporary lesion causes subjects to exhibit riskier behavior, also known as textbook perfect risk neutral behavior. This region also houses the right inferior frontal gyrus, suspected of containing human mirror neurons. Mirror neurons are instrumental in anticipating what peers will do and why. Losing mirror neuron function results in autism like behaviors. Using mirror neurons is sharing a dream in a manner not unlike mark to market, precedence, and social signals.

Research analyses focusing on finding and erradicating the social signal root of price divergence from intrinsic worth ignores the fact that intrinsic worth may be inextricably tied to social signals. Unless the intervention controllers seriously wish to entertain the notion of lobotomizing investors and traders to highly uncertain and potentially even more extreme market destablizing effects, bubbles may be a fundamental part of markets and human nature.

A bubble is a temporary yet significant peak in asset prices. The ensuing trough that forms the bubble does by definition destroy value when compared to the peak. It may be a temporary destruction, depending on the timeframe and the associated job. Disrupting a bubble via aggressive intervention is still as yet controversial. In extremis, closed autocratic controlled economies practice such interventions for stability. It is far from clear if such a goal is desirable. Intuitively, a bubble attracts capital and labor. The collapse redirects it. There is something to be said about the economies of scale in attracting and redirecting capital and labor.

Instead of diving into the brain to understand bubbles and then ending up finger pointing the blame on why the ill-adapted brain causes irrational and off-model behavior and how to “fix” both brain and bubbles, perhaps one should dive into bubbles to understand the brain to the better understanding and exploitation of both.  The question would be why are there bubbles and herds?  The question would be what are the long-term effects?  The question would be to what purpose do our brains fit into bubbles?  Perhaps taking the less traveled route and leaving behind preconceived biases may yield more insight.