Mood and Decision-Making

Traditional psychology and economic theories hypothesized that people evaluate their desirability, and potential outcomes and combine all related information through an un- biased expectation calculus to make final decisions. Mood, as an emotional state and a transient state of feeling, has no impact on decision-making process. However, some psychology and behaviour finance research has attempted to dispute this conclusion and argued that mood plays a significant role in the decision-making processes (Damasio, 2008; Loewenstein et al., 2001). Emotional reactions to decision-making choices often diverge from usual cognitive assessments of those choices, emotional reactions often drive decision-making. The seminal work of Damasio (2008) demonstrated that emotions can violate or motivate rational thoughts by studying decision-making processes of people with impaired ability to experience emotions. Mayer et al. (1992) invented the term mood congruency in judgements to describe situations in which mood affects an individual’s thoughts, and influences that individual’s decisions through three sample studies. Ac- cording to their research, people with pleasant moods are more likely than those people with unpleasant to expect nice weather for outdoor activities, because their pleasant mood brings them optimistic expectation. McFarland et al. (2003) proposed that people with pleasant moods tend to judge those around them to be more blissful compared to those in an unpleasant mood, who tend to judge surroundings less favourably. Simple put, some recent literature has demonstrated that the emotional states of people have a great impact on their decision-making process. We have provided some more details about how mood influences decision-making process in chapter 2, therefore, in this section we focus on

how mood impacts trading decisions and ultimately stock turnover.

In finance markets, investors hold different risk perceptions and their investment decisions are mostly based on their risk preferences. Decision-making under risk and uncertainty is an very active research topic. Recent work has proposed that mood has a complex in- fluence on risk preferences and decisions involving risk-taking. An experiment carried out by Isen et al. (1988) focused on the relationship between induced positive affect and decision-making. They provided candy as reward to half of the participants in order to in- duce a positive mood, then these participants were asked to anticipate a decision-making gamble game with poker chips representing their risk perception. On each trial, partici- pants were required to indicate their choices for either a gamble that had both outcomes fixed at a particular amount of points (for example: the same points were rewarded or deducted depending on the occurrence of an event) and another gamble that had one fixed outcome and one variable outcome (the reward and punishment points were different). They found that participants with a pleasant mood demonstrated an increased preference for avoiding losses. The experiment concluded that individuals in a pleasant mood were more risk averse than individuals in neutral or bad moods. The argued that individuals in bad moods would image themselves having nothing much to lose, so being desperate and willing to select choices that offer the possibility of a substantial return, thus they tended to choose high risk and reward options. This experiment showed that people’ risk preferences are subjected to their mood, people in bad mood are more willing to engage in risk-taking activities, thus mood have a great impact on investors’ decision-making process.

An alternative view is that people tend to evaluate the future optimistically when they are in a pleasant mood. Wright and Bower (1992) showed that happy people tend to be

optimistic and, in contrast, sad people tend to be pessimistic. According to their study, investors with pleasant mood would expect a bull market and increase their buying activ- ities, anxious or depressed people tend to avoid risk and leave the market. Experiments performed by Eisenberg et al. (1998) further confirmed the argument. In the experiments, the subjects were college students in an abnormal psychology class at the University of Pennsylvania. They were asked to completed a questionnaire related to what they would choose in hypothetical decision-making scenarios, when choosing between a risky option and a relatively safe option. The results of the two experiments were replicated, both showed depressive symptoms correlated with anxiety and risk-aversion is correlated with both depression and anxiety.

In summary, the psychological studies cited above concluded that people’ risk prefer- ences are associated with their emotion status, and mood has a significant effect on the decision-making process. Investors are believed to be significantly affected by their emo- tion statues when engaging in stock market activities. For example, when investors are in a pleasant mood, they could be optimistic and expect a bull market, these investors are more willing to buy stocks; on the other hand, depressed investors tend to be pessimistic and leave the market. In this last section, we recognized that SAD is directly associated with mood, SAD sufferers are known to be seasonal depressed. Therefore, investors who suffer from SAD sufferers are depressed and pessimistic, they are more likely to adjust their investment portfolios.