Neurophysiological evidence on perception of reward and risk: Implications for trading under time pressure
Recent neurophysiological studies reveal that risk and reward are separately encoded in the human brain, and that the encodings display different timing patterns. Therefore, we hypothesized that sensitivity of trading decisions to risk and reward parameters would differ depending on time pressure. Consistent with this prediction, we find that decisions under extreme time pressure (1s delay time, with decision to be made in next 1s interval) reflect preference for expected reward and aversion to variance and skewness. With less time pressure (3s or 5s delay before decision), variance sensitivity disappears; sensitivity to expected reward remains the same and sensitivity to skewness increases. Buying impulsiveness emerges under extreme time pressure (subjects buy at higher prices, ceteris paribus), but is fully offset when more time is available. Prospect-theoretic preferences can capture decisions under extreme price pressure (including buying impulsiveness), but classical smooth expected utility preferences (constant relative and absolute risk aversion) cannot. Because choices reveal aversion to skewness but no aversion to variance, choices under less time pressure are inconsistent with either classical preferences or prospect theory. Our findings have implications for trading platform (market microstructure) design, incentives contracts, and for program trading.
Record created on 2016-08-29, modified on 2016-08-29