The amount and quality of sleep a person gets affects their financial decisions. Those who incur sleep problems are more prone to display behavioral biases such as putting more emphasis on the present than on future payouts and misunderstanding probabilities.
According to a recent study, the likelihood of placing more emphasis on a low probability outcome and underestimating the chance of a high probability outcome is greater for those who lack sleep or experience poor sleep quality. Poor sleep quality is also inversely related to loss aversion (the unwillingness to incur a loss). Those who have a harder time falling asleep are more likely to take a smaller payout now than wait for a large payoff in the future.
“Individuals who have better sleep, better sleep quality, and fewer sleep disturbances distort the probability of gains and losses less, which allows them to make better financial decisions. Similarly, worse sleep quality and more sleep disturbances are related to increased risk taking. This demonstrates that improper sleep can impact financial decisions with individuals taking more risk, which individuals need to be aware of to ensure rational decisions. Finally, poor overall sleep is related to being more susceptible to the present bias of overweighting outcomes that are closer to the present, suggesting more irrational financial decisions,” the study’s authors stated.
One reason for this may have to do with the prefrontal cortex. Previous studies have found that this region of the brain is activated during decision-making. It is responsible for irrational decision-making, including selling winners and holding onto losers (the disposition effect) and for buying during market bubbles. A loss of sleep weakens the prefrontal cortex’s neural functions, leading to more behavioral errors.
The findings are based on a study of upper-level undergraduate finance and economic students. These students were chosen, in part, to control for the role financial knowledge may play in the behavioral biases. Sleep was analyzed using the Pittsburgh Sleep Quality Index, which considers factors such as the number of hours slept, the quality of sleep, the use of sleep medication and how quickly a person falls to sleep.
Source: “DEEP Sleep: The Impact of Sleep on Financial Risk Taking,” by John R. Nofsinger, Ph.D., and Corey A. Shank; SSRN, April 2018.
Behavioral Finance
Behavioral Finance
Beginning Investor
Jim M from PA posted over 8 years ago:
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