Financial markets are social23.09.2018
The capstone event of the INSOSCI project will be a book symposium on the social brain, to be held at February 12-13 2019 at Witten Herdecke University. What does the term ‘social brain’ mean when dealing with financial markets, in disciplinary terms? I think it implies a strong role of sociology. And indeed, there is a branch in sociology that is labelled ‘sociology of finance’. However, if my impression is correct, this is totally ignored by economists and even behavioural economists.
If the brain is social, can we just say that markets are social institutions and that therefore doing good economics is enough? Does the integration of neuroscience and economics need the input by sociology? I think, yes. Perhaps one personal experience shaped this belief: When I taught cross-disciplinary finance at the Frankfurt School of Finance and Management in 2009 and 2010 (later that was deemed irrelevant by the leaders and scrapped), students told me that the sociological texts were the first ones they met at the School in which the real world of finance was described, as they experienced it (often doing part time work in the Frankfurt banking industry). They had troubles in connecting the models of the theory of finance with their life-worlds.
One of the intellectual leaders of the sociology of finance, Donald MacKenzie pointed out in his classic ‘An Engine, not a Camera’ that behavioural finance may overlook the fact that social processes embedding financial markets may neutralize individual behavioural ‘irrationalities’. His argument was directly referring to the social processes that lead to the application of theories in practice, so appears somewhat specific. Another leader in the field, Karin Knorr Cetina, introduced the concept of ‘scopic markets’ to grasp a defining characteristic of financial markets that is well known to readers of Keynes: That these markets are media of mutual observation of participants in many dimensions. Specifically, even anonymous market transactions are interpreted as expressions of states of mind of others, so that the entire market is system of myriads of mirrors. Interestingly, there is neuroeconomic evidence that under certain experimental conditions, markets activate the ‘Theory of Mind’ modules in the brain, as if the market itself were a human being. This seems a nice illustration of what ‘scopic’ means.
In the good old days of trading with physical co-presence, this embeddedness of markets in social interactions was performed in an almost dramatical way, in the pit. Participation in the pit required a long socialization process and successful advancement in the hierarchy of traders. The pit was an embodied status order, with ‘big’ traders occupying the positions that allowed better observation of others. Everybody was watching market data, but at the same time the emotions, facial expressions, and gestures of others. This is the ‘real’ financial market, and not the abstraction of the theory of finance.
Why does that matter for neuroeconomics? It matters because we might presume that motivational structures and mechanisms work differently as assumed in the theory of finance. A central point is the fact that traders assign status to each other. Status reflects past success, but also other attitudinal aspects, such as respect for the moral rules in the trading community. In her anthropological work, Caitlin Zaloom showed, among many other observations, that in this status order behavioural disciplines are learned that directly affect standard assumptions in behavioural economics: For example, traders learn to suppress sunk cost effects, endowment and disposition effects, and loss aversion.
Sociological research produces important insights. The recent work by Gemayel and Preda is an excellent example. Many people may think that digitalization drives the human element out of finance. However, Knorr Cetina and Brückner (2002) have shown early that traders actively undergird and merge the digital systems with other virtual lines of communication that re-embed the market in the social. Gemayel and Preda look at an institutionalization of this, the social media trading platforms which explicitly show the transactions and accounts of members. On the one hand, this may demonstrate that there is a demand for embedding finance socially. On the other hand, this means that we need to take into account specific effects resulting from that. Status orders can have effects that work in different directions, as far as behavioural anomalies and irrationalities are concerned. Gemayel and Preda (2018a) show that herding tendencies may be enhanced; Gemayel and Preda (2018b) demonstrate that the disposition effect becomes weaker, similar to Zaloom’s observations mentioned previously.
I think that these insights are extremely valuable in any attempt at building a unified framework for neuroscience and economics. Probably sociology can offer an overarching framework, one we realize that financial markets are social.
De Martino, B., J. P. O’Doherty, D. Ray, P. Bossaerts und C. Camerer (2013): In the Mind of the Market: Theory of Mind Biases Value Computation during Financial Bubbles Neuron 79 (6), S. 1222-31
Gemayel, Roland, und Alex Preda (2018a): Does a Scopic Regime Produce Conformism? Herding Behavior among Trade Leaders on Social Trading Platforms“. The European Journal of Finance 24: 1144–75. https://doi.org/10.1080/1351847X.2017.1405832
Gemayel, Roland, und Alex Preda (2018b): Does a Scopic Regime Erode the Disposition Effect? Evidence from a Social Trading Platform“. Journal of Economic Behavior & Organization 154: 175–90. https://doi.org/10.1016/j.jebo.2018.08.014.
Knorr Cetina, K. (2012): What is a Financial Market? Global Markets as Microinstitutional and Post-Traditional Forms, in Knorr-Cetina, K. und A. Preda (Hrsg.), The Oxford Handbook of the Sociology of Finance, Oxford
Knorr Cetina, K. und U. Bruegger (2002): Global Microstructures: The Virtual Societies of Financial Markets, American Journal of Sociology, 107 (4), S. 905-950
Zaloom, C. (2004): The Productive Life of Risk, Current Anthropology, 19(3), S. 365-391
Zaloom, C. (2012): Traders and Market Morality, in Knorr-Cetina, K. und A. Preda (Hrsg.), The Oxford Handbook of the Sociology of Finance, Oxford