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The Role of Emotions in Financial Decisions

Abstract

This paper focuses on decision-making in the face of the uncertainties and catastrophes for which the insurance industry provides cover. It introduces ideas about the role of narrative and emotion in financial markets and the concepts of phantastic object, divided state and groupfeel. The author argues that the major insurance institutions are necessarily leading players in the financial industry and have an opportunity to play a leading role in making the world safer. One possibility is to emulate Barbon and those who developed fire engines and building regulations by seeking to construct a new framework for pensions and savings in which the destructive consequences of the way competitive asset management works are mitigated by creating new rules of engagement. Other possibilities might involve intervention to make clear the inevitable losses that follow from the ongoing destruction of the global commons.
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
1
The Role of Emotions in Financial Decisions.
It is a pleasure and honour to be here and to join you to celebrate the centenary of the
granting of your Royal Charter.
As you know these lectures are held in honour of Nicholas Barbon or (as his father
named him in 17th century tradition) Nicholas If-Jesus-Christ-Had-Not-Died-For-
Thee-Thou-Hadst-Been-Damned Barebone. He was a child of the English revolution
born at the outbreak of the Civil War and dying ten years after the Glorious Revolution
of 1688.
Like many of his time he was a polymath - economist, physician, housebuilder, financial
speculator and pioneer of fire insurance. A revolutionary, he was one of the great critics
of mercantilism and first proponents of the free market. It seems to me that his career
and his views nicely illustrate the possibility in a free society of a happy conjunction
between the pursuit of private gain and its potential to achieve the common good.
Insurance companies seek to profit, reasonably enough, by offering protection against
risk. But today risks have become more complex and inter-connected than in Barbon’s
day. Looking at the World Economic Forum’s recent Global Risk Report we face a vast
array of global economic and political challenges.
You know this.
Chartered Insurance Institute papers on your website suggest that the insurance and
financial services industry should try to be “one step ahead” and to try “to provide
comprehensive insight into the changing nature of these challenges, and to recommend
credible courses of action in the face of them.”
This evening in the context set by such statements I will focus on decision-making in the
face of such uncertainties and the catastrophes they suggest we risk. I will use the
Table 1 Risk Categories from the World Economic Forum Annual Report 2012 (Courtesy WEF)
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
2
opportunity to introduce you to some aspects of some new and relevant ways of
understanding the psychology of human decision-making which may be of interest to
you.
For the past few years, generously supported by the Leverhulme Trust, the Chartered
Financial Analysts Institute and now the Institute for New Economic Thinking, I have
been trying to bring together my professional training and clinical experience as a
psychoanalyst (preoccupied with the role of emotion and subjective experience in
human life) with my training in Economics and Sociology, to understand how emotion
impacts financial markets and what we should do about it.
Today, after several years in which bank runs have been more or less threatening to
reduce the global economy to chaos (and some of you have been having sleepless nights
wondering how to secure the assets derived from premium income) I suppose it is
rather easy for you to see that emotion plays a major role in economic life and that
matters to which we have not been paying attention have opened up fault lines in our
political and economic institutions, as well as in the governance structures of banks and
other major companies.
Reason and Emotion
Reason and emotion are often viewed as opposed in gatherings of this kind and
especially where there is a predominance of men.
Let me be clear at the beginning, therefore, modern developments in psychology and
neuroscience go beyond the cognitive revolution of the 20th century and do not see
things that way. The consensus view today is that far from being a hindrance, emotions
are vital to good decision-making.
Evolutionary processes have seen to it that successful adaptive decisions are aided by
emotions in the form of bodily states. The brain is part of the body and has been
developed to aid body functioning and homeostasis. The underlying mechanism
involves what can be termed somatic markers - physiological reactions that track
previous emotionally significant events stretching back in our individual histories.
Briefly, what this means is current events are mapped or marked in our minds
according to the emotional consequences they had in the past. In this way, emotion is
able to fulfil the vital role of informing action (including processes of attention and
perception) very rapidly and mostly beyond consciousness. Overwhelming evidence
now supports the view that there is an almost continual interchange between brain
networks associated with feelings (in the Amygdala, for instance) and conscious
thoughts (in the prefrontal cortex, for instance) and, therefore, that there is a complex
two-way communicative relationship between conscious and unconscious processes. It
is very mistaken to view this as a two-system conflict as if there is a fight inside us
between an emotional and rational self. In fact, higher order cortical functions
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
3
permitting reflection and complex analytical capacities (system 2 in Daniel Kahneman’s
language) operate in tandem with, not against, emotional unconscious processes (in
system 1).
All this permits faster and more survival-effective decision-making, especially in
conditions of novelty and radical uncertainty. In fact I would say that widely held beliefs
about the superiority of reason over emotion are probably dysfunctional anxiety-
generated defences against feelings of loss of control, themselves based on earlier
somatically-marked experience.
In what follows I shall try to draw out the consequences of this new understanding and
introduce some concepts based on it. I will argue that the major insurance institutions
many of you represent, as leading players in the financial industry, have an opportunity
to play a leading role in making the world safer. For example, one possibility is to
emulate Barbon and those who developed fire engines and building regulations by
seeking to construct a new framework for pensions and savings in which the destructive
consequences of the way competitive asset management works are mitigated by
creating new rules of engagement. Other possibilities might involve intervention to
make clear the inevitable losses that follow from the ongoing destruction of the global
commons.
The Dawn of Insurance
Insurance (the co-operative pooling of risk) has its roots in the dawn of Homo Sapiens
and her evolutionarily developed capacity for team work and language.
The individual and collective awareness of risk and the experience of loss create
potentially catastrophic survival anxiety. The co-evolution of biology and social
institutions have enabled pooling of individual resources leading to increased life
chances. So from the dawn of time human groups developed social institutions to
protect themselves and to manage the anxiety that encounters with uncertain
experience created. We could say, in fact, that it was the psychological and social
management of survival threats that led to the development of religious and social
practices including, at a very early stage, formal mechanisms for the pooling of risk
known already in the Chinese and Babylonian civilisations of the 3rd and 2nd millennia
B.C.
Entrepreneurs like Barbon followed. He found ways to organize the pursuit of economic
advantage for himself and the pursuit of protection for all. My point is that at the heart
of insurance is the pooling of risk and the development of trusting collective relations.
Of course, one problem has always been moral hazard and “free-riding” - the pursuit by
any one individual of a strategy to exploit the others, be it initiated by consumer fraud
or company fraud. But the whole system would be unworkable without trust.
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
4
Most importantly, a major consequence of the development of commercial insurance
has been the creation of an interest group, a collective, with an interest in seeking to
mitigate risks at the social level - historically paying or lobbying for such things as fire
brigades, marine safety regulations, housing safety regulations and so on. In this way,
insurance as a form of social organization succeeded not only in compensating victims
but in reducing the risk of becoming a victim as well. Insurance companies, in other
words, when they work well together, solve what economists call a collective action
problem in which multiple individuals can all benefit from a certain action, which
because of its associated costs might implausibly be undertaken by individuals alone. In
such circumstances, co-ordinated action achieves greater benefits for all.
New Economics
In the twentieth century Economics somehow achieved for itself the status as the most
successful social science. Economic modelling provided some understanding of the way
free global markets can operate to produce benefits that have no hope of being achieved
under command system alternatives such as those so disastrously attempted in the
Soviet Union and Mao’s China. Such economic thinking has provided the basis for the
reform of institutions and for economic policies that at least for a while appeared to
achieve improving employment and living standards. The processes of globalisation
lifted hundreds of millions out of poverty, drove down costs and massively improved
the availability of a wide range of innovative goods and services.
In the process, the concept of homo economicus has come to dominate conceptions of
human decision-making with very widespread consequences. Allegedly, atomistic utility
maximising “rationally” calculating economic agents co-operate only when they identify
narrow individual incentives to do so and are immune to what is going on among their
fellow humans. True, if the system fails to price the consequences of their actions, there
are negative externalities or spillovers around them but according to theory, these can
be mitigated by compensation and pricing policies.
The limitations of this viewpoint (and the liberal economic thinking and policies based
on an idealised ideological version of it) now threaten potentially irrevocable damage to
the global commons. Information asymmetries and imperfect competition lead to less
than optimal outcomes even in deductive theory-making and our ability to know how to
create compensatory systems in practice is a myth, particularly in the face of limitations
imposed by bureaucracies, interest groups and access inequalities, not to mention
uncertainty and interactive complexity which often make it very unclear what to do. In
large measure individuals and even large corporations are in fact often helpless to
mitigate negative externalities, especially if problems extend beyond the influence of
the nation states in which they live who are not all equally and severally incentivised to
act. There are significant collective action problems.
But the homo economicus perspective is also, in very simple terms, wrong. The evidence
from modern psychology, neuroscience and the other social sciences is that narrow
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
5
pursuit of self-interest is not the only basis for human decision making and that human
beings have a much more extended range of motivations. As my colleague Professor
Dennis Snower of the Kiel Institute for the World Economy has put it, we need new
economic thinking to ensure our survival - thinking that takes account of the fact human
beings have been biologically prepared to co-operate in teams, to care for one another
beyond individual economic or even survival interest and to derive pleasure from doing
so as well as from punishing those that appear “unfair” and do not do so. Economic and
business policies based on the assumptions of homo economicus will mislead. A stable
economy and a sustainable world needs new ways to be found to model complex
economic interactions using variable assumptions about what motivates people. Very
different conclusions may result. Commercial reputations, for example, can be severely
and very rapidly damaged if companies too ruthlessly and greedily pursue cutting costs
or exploit comparative advantage. What they may risk is creating unexpected
reputational damage and then become perceived as exploitative, uncaring or unfair with
huge potential costs. The cottage cheese boycott in Israel a year ago is an example.
Decision-Making Theory
A particularly significant way in which economic policy is negatively influenced by
wrong assumptions about human decision-making has been the retreat from the lead
Maynard Keynes provided when he distinguished between risk and true uncertainty.
The distinction led him to stress how economic actors seeking to make long-term
investments could not overcome uncertainty on rational calculating grounds but to act
had to be impelled by “animal spirits”. True uncertainty implies that the future is not
captured by probability distributions or, in other words, means that to rely on statistical
representations which project the past into the present is dangerous. They can provide
a basis for thinking and judgment at best. (This is the problem of course with the
current panoply of concepts such as risk wrappers, Value at risk, optimised portfolio
allocation and the idea that many synthetic financial derivatives can be priced at all.
Calculating risks of that sort is an entirely different matter than, for example, calculating
the likely outcome of drawing coloured balls from a defined urn or most actuarial risk,
where it is reasonable to suppose we have an expected distribution.)
When we take uncertainty seriously I want to suggest to you that existing economic and
policy thinking, based on inaccurate psychology including the traditional decision-
making axioms at the heart of microeconomics - seriously misleads us. I will illustrate
the core concepts that are relevant to understanding action in a world with real
uncertainty phantastic objects, divided states and group feel by introducing some
findings from a research study I did with equity investment managers. In my view they
apply much more broadly.
In 2007, I conducted a systematic interview study with 52 very experienced money
managers using stock-picking and/or algorithmic dependent techniques responsible for
managing $500 billion every day (Tuckett, 2011).
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
6
They told me in detail about examples of their daily work and I listened and probed
their answers until I could understand them. The results are set out in my book.
Such interviews allowed me to recognise how some well-known but not sufficiently
considered features of financial assets provided the context in which financial managers
had to make decisions such that I argue financial markets are primarily markets in
stories and that as such, as currently configured, they are inherently and dangerously
unstable.
Financial assets are very different to other objects bought and sold, for instance TV sets.
In fact, they have three fundamental and distinctive characteristics which necessarily
create uncertainty, information ambiguity, and emotions, with many consequences for
making decisions to buy, hold or sell them.
First, asset prices are very volatile in time hourly, daily, monthly, annually. This
fact engages curiosity and emotion: particularly excitement about potential gain when
they go up, providing opportunity; and anxiety about potential loss when they go down,
signalling danger. Many charts have been drawn in the last hundred and fifty years to
try to detect patterns. But in truth the volatility distribution of financial assets is neither
random nor Gaussian, nor predictable in advance. It is path-dependent to a degree but
not to a predictable degree.
Second, financial assets are abstract entities
They have no value in and of themselves. Prices can go to zero a possibility certainly
engaging emotion.
The future price of any individual asset depends, therefore, on imagining how future
cash flows will be generated in a competitive market and the complex interactions of
the views of others about such scenarios. Put another way prices are conjectural,
around an imagined but (ex ante) unknowable and uncertain future reality.
Third, feedback about portfolio performance managing assets is fuzzy.
It is not possible to be very certain if good or bad investor portfolio performance
represents skill or luck. Academic research finds almost no evidence for skill over luck.
Certainly around four out of five asset managers cannot outperform a passive index
after taking account of fees. It is a zero sum game.
Day-to-day feedback from portfolio performance from the viewpoint of any individual
manager is time-dependent and uncertain. What look like a good set of portfolio
decisions (ex ante) can easily turn out to be bad ones later. In addition, what look like
bad ones (ex ante) can be revealed in time to be great ones.
Manager evaluation (ex ante) is, therefore, uncertain although competition for the
management fees obtained is intense and based around “outperformance” narratives.
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
7
Unsurprisingly in this context manager selection and asset allocation data shows
herding. Most seriously in this context learning from experience is very difficult -
insofar as results are equated with skill, they may actively increase learning difficulty.
Decision-Making under Radical Uncertainty
The gentleman in the picture is looking at his telescope
from the other end. Given the nature of financial assets,
traditional decision theory also produces an actively
misleading perspective whether taken into economics
as traditional rational expectations or as modern
behavioural finance. Research has been based on
normative principles given a subjectively desired
outcome, optimising agents should adopt probabilistic
reasoning methods as if problems are well-defined. In
standard economics, this happens by assumption, in the
behavioural variant there are biases and errors.
However, the decision-making context I have described and which financial agents
actually face is different information is ambiguous and the consequences of theirs’ and
other agents actions unknowable in advance. Ex ante, there are no correct decisions.
No probability distribution of the outcome data can be sensibly constructed and
outcomes are radically uncertain. What to do is fundamentally uncertain a matter of
judgment and waiting.
However, in this situation financial agents are nonetheless required to take decisions
and also to maintain them often for lengthy time periods - and to do this “in public”
while strongly incentivised to believe they could earn exceptional returns by doing so.
To be realistic, therefore, the focus of analysis must change away from examining how
agents make optimal decisions towards understanding how it is agents come to feel
comfortable enough to act at all - and then to examine what implications that process
of becoming comfortable might have for understanding aggregate outcomes.
This perspective, given our growing psychological knowledge, in fact changes
everything.
Narratives how choosing from uncertain options become compelling?
The new idea (which in many ways you all know very well) is that when investors buy,
sell, or hold all classes of financial assets what they are doing is constructing narratives
about their future relationships with an imagined idea.
It is the narrative about a given option that makes that option compelling.
Human beings construct mental “object” relationships all the time. They create stories
and tell them to themselves about them and their projects such as with plans to go on
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
8
holiday, buy houses, enter sexual and emotional relationships or have children. In doing
so they draw on biologically evolved capacities for attachment and imagination
In their simplest form, such imaginative relations are stories told in the mind about the
imagined emotional relationships we have with the objects of our desire. As they are
constructed such stories evoke ambivalence - good and bad feelings as for example,
when imagining I love him, he likes me, I hate her, she makes me anxious, and so on. The
volatile behaviour of financial assets creates emotional conflicts there are reasons to
love or hate them or even sometimes to be bored by them. As with the other
attachments we form with people or projects, we can be alternately rewarded or let
down. We can doubt them and suspect the objects of our attachment. We can admire
them or get angry with them. It is subjective feelings of this kind which provide meaning
and emotional motivation and so the support for action.
Faced with the need to act when outcomes are radically uncertain and when there is
reason for doubt and suspicion as to the usefulness of the information they have to
hand, financial agents necessarily must find ways to create optimistic narratives about
future relationships with the assets that in fact threaten them with uncertain rewards
and punishments.
So to be compelling their narratives have to be optimistic enough to be experienced
positively through time, despite the constant ambiguity and uncertainty as matters
progress. Their must enable them to be more attracted to the object (the idea) than put
off it so that doubts and distrust can be overcome. And given the price volatility which is
a characteristic of financial assets, narratives must allow them to persevere through
time despite potentially worrying signals as prices move and news comes in.
It is easier to think of this process in relation to stock picking but with time I can
demonstrate it is just as present with broader styles of investing or with any activity
involving a future long-term relationship.
Narratives order information and experience and tend to close perspectives on
situations to create meaning and consistency. They are an evolutionarily evolved way of
creating meaning and supporting action. Human beings are equipped with almost
infinite powers to turn data into patterns and tell themselves and others convincing
stories. It can lead to error but it is how the mind makes sense and manages
uncertainty.
The implication of all this should be clear - given that the prices of financial assets
cannot be set by fundamentals which are unknown and in future unknowable they
are set by stories about fundamentals specifically the stories which market
consensus at any one moment judges true. Moreover, because which stories are most
popular and judged true can change very much quicker than fundamentals, asset
valuations can change very rapidly indeed as we have been seeing.
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
9
Phantastic Objects
To describe this situation further Richard Taffler and I developed the concept of the
phantastic object.
Phantastic Objects are subjectively very attractive or idealised “objects” (people, ideas
or things) which we find highly exciting. We idealise them, imagining (feeling rather
than thinking) that they can satisfy our deepest desires, the meaning of which we are
only partially aware. Through idealisation they stimulate attachment and ease
dependence anxiety.
To make financial decisions requires the creation of compelling narratives to support
action in uncertainty. When analysed, decisions to buy and hold narrate stories about
situations of gain with little risk. Each story contains attracting features and at the same
time features which manage or repel anxiety and doubt.
Such stories have the constant potential to turn into phantastic objects mental
representations of something (or someone) which is idealised to the extent it is believed
to fulfil the protagonist’s deepest desires. The paradigmatic examples are tulip bulbs,
dotcom stocks, and, in the recent past, certain classes of financial derivatives and
Eurobonds. In all cases there is a good idea underneath which is a promise of increased
reward for less than usual risk. There is attraction to gain. Doubts and risk are repelled.
Phantastic Objects are compelling for biological reasons. They form the basis of human
attachment and seem to me to underpin optimistic-exceptionality myths throughout
finance not just dotcoms and the like but also star asset managers, star analysts, star
management teams and new exciting new methods and opportunities. As Daniel
Kahneman concedes, “When action is needed optimism, even of the mildly delusional
variety, may be a good thing.” (Daniel Kahneman (2012) Thinking: Fast and & Slow. p
256.)
Divided States
The state of mind we adopt when making uncertain decisions is crucial. The problem
with phantastic objects, of course, is that they are inherently unrealistic. We idealise to
make it possible attach ourselves and to overcome the problems of uncertainty and
ambivalence or doubt.
But when there is awareness of ambivalence (doubting or not liking as well as wanting)
there is an experience of unpleasant conflict creating the potential for what I term a
Divided State of Mind An alternating incoherent state of mind marked by the
possession of incompatible but strongly held beliefs and ideas. Thinking in this state
inevitably influences our perception of reality so that at any one time a significant part
of our relation to an object is not properly known (felt) by us. The aspects which are
known and unknown (split off) can reverse but the momentarily unknown aspect is
actively avoided and systematically ignored by our consciousness.
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
10
Divided mental states can be contrasted with more complex Integrated mental states
in which ambivalent thoughts and the unpleasant and exciting feelings they stimulate
can be retained in awareness and so become the object for conscious thought.
To believe in phantastic objects tends to require and indeed to stimulate divided states
so that phantastic object narratives will tend to underemphasise or dispose of doubt.
There is clear evidence of this in dotcom narratives, in the narratives surrounding
financially engineered derivatives and their potential to spread and remove risk and in
the entire organization of financial markets for instance, based around the advertised
belief exceptional outperformance is a realistic goal for money managers.
The theoretical potential of a divided state is that it highlights the potential for
disturbed thinking for unthinkingly behaving in a way that somewhere one knows
should worry one and cause pause for reflection (anxiety has somatic manifestations
like head or backache). Divided states are adopted and maintained partly because
awareness of the underlying emotional conflicts is frightening, embarrassing or
frustrating. For this reason, once decisions have been taken in a divided state getting
back to a more realistic (integrated) state is only possible with considerable mental
work, as in mourning or coming to terms with guilt.
Divided states and the kinds of processes that took place running up to the crisis are
facilitated and supported by what I term groupfeel - a state of affairs where a group of
people (which can be a virtual group) orient their thoughts and action to each other
based on a powerful and not fully conscious wish not to be different and to feel the
same. What we can think of a a “work group” functions in relation to the “real” task of
the group so that its members work as a team utilising individual talents in relation to
what they seek to achieve. In contrast when a group functions as a “basic assumption”
group, it is captured by Groupfeel. Group members are more preoccupied with the
relations within the group and in the maintenance of the group (feeling good) than with
the work task, which becomes subordinate to their relations with each other. Such
states probably have a biological basis in the need for human groups to face adversity
together. They lead to what is commonly known as groupthink, which is a really
divided mental state operating on a group rather than individual basis.
Groupfeel supports the pursuit of phantastic objects in a divided state.
Financial Instability
From the viewpoint that financial markets are markets trading stories that evoke
combinations of excitement about gain and anxiety about loss they are, especially in the
highly competitive group situation money managers work in, constantly at risk for
developing divided states and beliefs in phantastic objects, which will constantly tend to
make adequate assessment of risk impossible. In divided states, for instance, issues such
as default risk (or perhaps underwriting risk), can go un-noticed. Many years ago, my
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
11
father, who was a Lloyds underwriter, would complain that competition for premium
income would frequently create just that effect.
From this viewpoint, asset price bubbles are endogenously constructed created by the
operation of the market itself. In financial markets decision-makers have to manage
uncertainty and volatility and in them stories circulate which regularly allow prices to
depart from long-run historical fundamentals. When this starts to happen in a big way,
as in all past asset inflations, warnings are invariably issued but also invariably ignored
or dismissed with degrees of contempt “This time is Different”, as Reinhart and Rogoff
put it.
The future is uncertain and we do never know which innovations will take off. But in a
divided state this is exploited by the pursuit of phantastic objects supported by “this
time is different” assumptions and so happens without proper enquiry. Groupfeel adds
to the fever and everyone else seems to be doing it. It is very expensive emotionally and
financially to say “no”. The essence of the situation is that it is not a bubble until the
crash.
Regulation and protection
Financial markets in stories in which aggregate decision-making under uncertainty is
liable to create phantastic objects, divided states and groupthink (something very
evident in the development of the Euro crisis) create instability and have very serious
consequences I don’t need to elaborate. They also create serious misallocations of
resources of land and capital and particularly human talent. Excitement about the
fantastic gains to be made in finance has created the financialisation of society and
many new risks. Such markets are unstable and out of control and cannot be left to
themselves. We need financial markets and as pension providers you need asset
management focused on long-term growth in the value of the underlying assets. But we
have a collective action problem.
What can we do? What can you do?
First, I believe that the concepts I have just attempted to introduce are very well worth
while your understanding in much more depth than I have had time for this evening.
They will, I suggest, prove a great deal more useful for mitigating risk than the standard
concepts of utility maximisation and rational expectations. This will be so from financial
risk through to the many other risks facing us. Divided states are relevant to how we
manage conflicts there are always conflicts in your business and they can be managed
but not solved for instance, how much expense to devote to consider what you must
put aside to manage true uncertainty? In a Divided State you will slide away from
confrontation with anxiety.
Second, we need to grow up. Economic theory based on ruthless individualistic utility
maximisation is, literally, an adolescent theory based on a very small child’s notion of
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
12
the world. In such theories mum and dad are simultaneously all wrong and don’t know
how to do anything and always there to pick up the pieces. Instead of mum and dad
think regulators and as consequences think regulatory arbitrage and regulatory
evasion.
When I say we need to grow up, I mean that we need to recognise these problems
cannot be left to individuals and we have to create institutions to solve our collective
action problems and to do so fast. Whether in finance or broader questions of
environmental protection we need good regulation and cannot continue the “Tom and
Jerry” approach to it. While individual financial institutions can gain as “free riders” the
collective interest of the membership of the CII and their customers is to work together
for the common good. This applies to financial regulation and to the regulation and
institutional work needed to face many of the major challenges facing us most
obviously climate change. Adolescence is the exploration of phantastic objects in
divided states; it leads to disaster if the containing parental environment, providing
integrated state thinking allowing sometimes painful learning from experience, fails.
Although only some of you are directly involved in pension provision all of you are
affected by financial market instability so I will now illustrate my idea about how you
could engage in collective action in that sphere. It could and should also be in others.
To be practical in the financial area, it seems to me that you in the industry should join
the kind of recommendations being put forward by the Kay Commission and:
1. Take the lead in exploring how to reduce volatility (probably by finding ways to
limit trading and penalising short holding periods). The current argument that
trading increases liquidity and price discovery is not sustainable, if asset prices
reflect stories.
2. Take the lead in how to re-present asset management choices to the public,
ensuring both that the facts about overall performance are much more clearly
known and seeking to work with the FSA and other bodies to bring down fees
and reduce competition by meaningless short-term performance statistics. To do
this requires accepting the current situation is not working and working through
the need to make finance less exciting. Everyone needs to be much more anxious
about pursuing phantastic objects or presenting themselves as able to find them
however depressing to excitement that may be. Much more realistic levels of
executive pay, linked realistically rather than fantastically to actual performance
over the right time periods are also indicated.
3. Take the lead in implementing Board governance reform to improve the ability
of Boards to adopt “integrated” rather than “divided” states of mind and the
associated groupfeel that has quite clearly characterised past approaches to risk
assessment.
More generally, as the World Economic Forum has identified by placing “Global
Governance Failure” at the centre of its global risk assessment, it seems to me it is
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
13
important that such efforts should not be limited just to a local context. It would be
important for the insurance industry to campaign vocally and effectively for and not
against collective global solutions, for example, to mitigate financial and climate risk.
Idealistic? Unrealistic? That depends I think on the perceptions you have of the risks
facing us and their costs and whether you chose to approach the uncertainties in a
Divided State, or not. Bearing in mind what I said earlier about the inadequacy of the
economic assumption that individual motivations always trump caring for the other
ones, I think it possible you could devise new strategies to appeal to your customers and
their sense of community - also enhancing your reputations as organizations to be
trusted over the long haul.
Are we all really aware of the risks we run? Or are we in various divided states. How far
have you tried to gain an emotional understanding of how radical uncertainty can affect
your businesses? One way to test that would be to “war game” the risks facing you
deploying some of the concepts I am suggesting. We have a UCL group who think this
might be the best way to explore these issues and co-ordinate action to address them.
Some of you may know the story (told in a book by Gordon Barrass on the Cold War)
how in 1971 Marshal Grechko of the Soviet Union invited Brezhnev and some of his
colleagues to take part in a “war game”, seemingly hoping to stiffen their resolve in
dealing with the harsh realities of a nuclear war. “The exercise began with generals
describing the impact of a surprise attack by over a thousand American missiles. They
grimly explained that 80 million people would be killed, the armed forces obliterated,
85% of industry destroyed and European Russia so irradiated as o be uninhabitable.
General Danilevich recalled that ‘Brezhnev and Kosygin were visibly terrified by what
they heard’. Marshall Grechko then asked Brezhnev to push a button that would launch
a “retaliatory strike”, which in reality involved the launch of just three missiles with
dummy warheads along a test range. Brezhnev turned pale, began perspiring and
trembled visibly, He repeatedly asked Grechko, ‘Is this definitely an exercise?’ The
leadership were traumatized by the experience. None of them ever again participated in
such an exercise. Brezhnev immediately ordered yet tighter controls to ensure there
could never be unauthorized use of Soviet nuclear weapons.” It was subsequently clear
that none of the leadership wanted a nuclear confrontation, especially Brezhnev, who
was a bon viveur of the first order. From then on they worked much more urgently on
negotiations to limit nuclear weapons and reduce their deployment.
My parting question to us all: how far have we participated in exercises which really
allow us to feel the impact of the challenges and risks facing us? And what can we do to
help leaders everywhere do so? Evidence from the financial crisis suggests divided
states are all too easy to create and that Board governance didn’t work.
This paper is the text of the annual Nicholas Barbon lecture given (in celebration of the Chartered Insurance Institute
Centenary) on May 24, 2012 © David Tuckett 2012.
14
References:
Tuckett, David (2012) Financial markets are markets in stories: Some possible
advantages of using interviews to supplement existing economic data sources. Journal of
Economic Dynamics and Control, Available online 2 April 2012, ISSN 0165-1889,
10.1016/j.jedc.2012.03.013.
_______(2011) Minding the Markets: An Emotional Finance View of Financial Instability.
London and New York: Palgrave Macmillan [Companion Website with randomly
selected interview transcripts: http://www.palgrave.com/finance/mindingthemarkets/
_______(2009) Addressing the Psychology of Financial Markets. Economics: The Open-
Access, Open-Assessment E-Journal, Vol. 3, 2009-40.
_______(2008) (with Richard J Taffler) Phantastic Objects and the financial market’s
sense of reality: A psychoanalytic contribution to the understanding of stock market
instability. International Journal of Psychoanalysis, 89 (2), 389-4
ResearchGate has not been able to resolve any citations for this publication.
Article
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This paper sets out to explore if standard psychoanalytic thinking based on clinical experience can illuminate instability in financial markets and its widespread human consequences. Buying, holding or selling financial assets in conditions of inherent uncertainty and ambiguity, it is argued, necessarily implies an ambivalent emotional and phantasy relationship to them. Based on the evidence of historical accounts, supplemented by some interviewing, the authors suggest a psychoanalytic approach focusing on unconscious phantasy relationships, states of mind, and unconscious group functioning can explain some outstanding questions about financial bubbles which cannot be explained with mainstream economic theories. The authors also suggest some institutional features of financial markets which may ordinarily increase or decrease the likelihood that financial decisions result from splitting off those thoughts which give rise to painful emotions. Splitting would increase the future risk of financial instability and in this respect the theory with which economic agents in such markets approach their work is important. An interdisciplinary theory recognizing and making possible the integration of emotional experience may be more useful to economic agents than the present mainstream theories which contrast rational and irrational decision-making and model them as making consistent decisions on the basis of reasoning alone.
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Fifty-two research interviews were conducted with money managers controlling over $500 billion. This paper presents detailed material from one interview to argue interviews usefully describe their shared reality and provide information about the conditions of action facing financial decision-makers with implications for aggregate behavior. Their shared reality was dominated by 'radical' uncertainty and information ambiguity which severely limited the scope for 'fully rational' decision-making. How they managed to commit to decisions was by creating narratives. The study suggests it may be useful to reconsider prejudices against the usefulness of talking to individual economic agents about what they actually do.
Minding the Markets: An Emotional Finance View of Financial InstabilityCompanion Website with randomly selected interview transcripts
_______(2011) Minding the Markets: An Emotional Finance View of Financial Instability. London and New York: Palgrave Macmillan [Companion Website with randomly selected interview transcripts: http://www.palgrave.com/finance/mindingthemarkets/
Addressing the Psychology of Financial Markets
_______(2011) Minding the Markets: An Emotional Finance View of Financial Instability. London and New York: Palgrave Macmillan [Companion Website with randomly selected interview transcripts: http://www.palgrave.com/finance/mindingthemarkets/ _______(2009) Addressing the Psychology of Financial Markets. Economics: The Open-Access, Open-Assessment E-Journal, Vol. 3, 2009-40.