In the Mind of the Market: Theory of Mind Biases Value Computation during Financial Bubbles

Summary

The ability to infer intentions of other agents, called theory of mind (ToM), confers strong advantages for individuals in social situations. Here, we show that ToM can also be maladaptive when people interact with complex modern institutions like financial markets. We tested participants who were investing in an experimental bubble market, a situation in which the price of an asset is much higher than its underlying fundamental value. We describe a mechanism by which social signals computed in the dorsomedial prefrontal cortex affect value computations in ventromedial prefrontal cortex, thereby increasing an individual’s propensity to ‘ride’ financial bubbles and lose money. These regions compute a financial metric that signals variations in order flow intensity, prompting inference about other traders’ intentions. Our results suggest that incorporating inferences about the intentions of others when making value judgments in a complex financial market could lead to the formation of market bubbles.

Highlights

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  Theory of mind can be maladaptive in complex institutions like financial markets

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  Dorsomedial prefrontal cortex biases signals in ventromedial prefrontal cortex

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  Both regions compute financial metric signals

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  Incorporating inferences about the intentions of others could lead to market bubbles

Abstract

De Martino demonstrates that the ability to infer the intentions and mental states of other individuals (“theory of mind”) biases evaluation when people interact with complex modern institutions like financial markets, contributing to the formation of economics bubbles.