By Saumen Chattopadhyay via Iris.xyz

The emotional core of our brain, the Amygdala, has the primary role of triggering fear responses. Information that passes through the Amygdala is tagged with emotional significance. If the market continues to decline, an investor could be under the influence of what is referred to as the “red-effect” by Elliot et al. (2007). Further research shows that even a two second glimpse of color red can have an important influence on our cognition, and behavior, and processing this color can undermine our intellectual performance – this phenomenon is called the “semantic red effect” [Lichtenfeld, Elliot et.al. (2009)]. Going beyond traditional finance, new research now combines neuroscience, psychology, economics and behavioral science in an attempt to explain how people make economic and portfolio decisions under uncertainty.

In an earlier blog on Trader induced Volatility and Market Correction, we defined excess market volatility, a concept that some academicians termed as “animal spirits”. The behavior of volatility during an environment when fundamentals are weak could be different from volatility-clustering – the tendency of volatility to persist in clusters, as a natural result of price formation process with heterogeneous beliefs across traders. Long term investors naturally focus on long-term behavior of prices, whereas traders aim to exploit short-term fluctuations. Although CBOE VIX® Index, the Fear Gauge of the market may have spiked, the absolute level is still low compared to the previous markers in 2018, let alone in 2008. Asness of AQR indicated in his recent post, this just ain’t a big number compared to the historical levels.

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