It wasn’t greed after all. Neuroscience shows that experts make illogical decisions when confronted with unprecedented circumstances, because experience can force you to unconsciously override logic in favour of your established beliefs. Experts in entirely unrelated fields need to be brought in on crucial decisions

If you are an expert, trust your intuitions. They help you make faster, more appropriate decisions. Especially in a crisis. So, logically, you would imagine that the best way to deal with a crisis is to leave it to the experts. No matter how bad the financial crisis was, nobody but the financial experts could put things right, right? Wrong.

This study: “The Illogicality of Stock-Brokers: Psychological Experiments on the Effects of Prior Knowledge and Belief Biases on Logical Reasoning in Stock Trading” pitted highly experienced professional stock traders against weather forecasters in experiments aimed at finding whether experts would succumb to “belief biases” when making 24 decisions where they had to choose between logic and “prior beliefs”.

The researchers did not determine whether bankers were any good at weather forecasting, but they did find examples of meteorologists significantly out-performing the pricing capabilities of 19 stock traders (the majority having a minimum of 10 years experience on the trading floor) in carefully devised experiments where deploying the received wisdom of an experienced stockbroker would produce incorrect judgements if given precedence over purely logical reasoning.

Here is a quotation from the report. It is taken from the discussion section.

“Stock-brokers were guided more by prior knowledge and existing beliefs than by logic and rational decision-making. In fact, they often tended to draw logically invalid inferences in favour of their existing beliefs. Thus, they had difficulties to disengage themselves from vastly anchored thinking patterns… Their performance was even inferior to that of a control group of meteorologists who had no experience at all with the stock market”.

Whereas the professor’s team was mostly interested in the cognitive science of the impact of prior beliefs, the financial world may need to look into the issues his research raises. Expertise is essential and unavoidable. But his research shows that you also need to bring a different resource ‘in the loop’. Staff whose qualifications are threefold.

First, no expertise in the field in question. Second, they need to be fully trained and tested in critical reasoning and logic. Third, they need to be put through tests based upon the same principles as those used in professor Knauff’s experiments, in order to see whether they produce decisions which are immune to the shortcomings identified in this study. And by the way, this of course applies to any mission critical field, not just finance.

The study is by Markus Knauff,  visiting professor, Cognition, Perception and Cognitive Neuroscience at the University of California Santa Barbara and Chair of Experimental Psychology and Cognitive Science Giessen University, Germany as well as Claudia Budeck, Ann G. Wolf, and Kai Hamburger.

So perhaps one day, when someone rings their broker in  a crisis and  asks “how bad is it?” instead of being told “it’s now time to sell everything” they may find themselves being told “it’s time we got a meteorological perspective on the situation”. Unless you’ve read this article, that answer will make no sense. But if nobody does, perhaps it may be too late for all of us.

The really good news is that this means we’ve finally found a popular role for bankers. They can be brought in to help out the weather forecasters if unexpected things start to happen. Their lack of expertise in this field will be more than welcome.

Publication details: Experimental Psychology and Cognitive Science, Justus Liebig University Giessen, Giessen, Germany. Antonio Verdejo García, Editor, University of Granada, Spain.

Conceived and designed the experiments: MK CB. Performed the experiments: CB. Analyzed the data: AGW. Contributed reagents/materials/analysis tools: KH. Wrote the paper: MK KH.
The article can be found on the PLos ONE (Public Library of Science) website. It was accepted on that site on September 19, 2010.