A common interpretation in behavioural finance is that rationality is the result of a pure cognitive process which can be behaviourally biased. In general, the bias has a negative connotation because it produces a distortion in the calculation of an outcome. When a decision-making process is cognitively biased the outcome leads to sub-optimal results or judgement errors. Roughly speaking, the subject might make irrational choices due to faulty reasoning, statistical errors, lack of information, memory errors, and the like. Differently, when the decision is biased by affective states, it means that the cognitive process has been influenced by feelings, emotions, moods, and so on. This leads us to irrational decisions or actions.

[1, 2, 3, 4]

In this interpretation, cognitive and affective processes are discrete and produced by two different systems: a cognitive and an affective system. While cognitive biases are influences that impact on rationality from within the cognitive system, affective biases refer to those influences that alter the cognitive system from outside.

Unfortunately, the assumption that rationality is a pure cognitive process is not well motivated. In fact, there is no rationality (or rational decisions) without affective states. Emotions, moods, and feelings are ubiquitous in the decision-making process: without them we would behave irrationally. In other words, rationality is the consequence of the intrinsic interaction between cognition and emotions, rather than the result of an independent cognitive process influenced by the latter.

Emotions and Decisions

Two examples can illustrate the role of emotions in our decisions. Imagine the following two thought experiments:

Ex. 1: An accident involving a car and a bus happened on a mountain road. The occupant of the car is someone you love (your husband, your wife, your child), and the occupants of the bus are people whom you have never met. After the accident both the car and the bus end up hanging on the edge of the mountain. You have time to save only one of the vehicles by pulling it with the crane of your car. Which one would you save?

In such a scenario, it seems clear that the most rational behaviour for most of us (if not all of us) is to save someone we love – the psychological consequences of not doing so might be devastating for us. Emotions play then an essential role in our decision. However, according to the common interpretation of rationality (a pure cognitive process) your decision has been biased. Does it mean that your decision has been irrational?

Ex. 2: Suppose that tomorrow is your wife’s (husband’s) birthday, things have not been working well lately, you both work long hours, you have had a couple of arguments, and the like. You know that she (he) would love to have this ring (watch) you saw together a month ago in a jewellery and you decide to buy the ring (watch). When you arrive at the jewellery you realise that the price is more expensive than you expected; if you buy it today, you will not be able to spend some money on other things that you like. But you have been told that next week, the item will be 50 % off. What would you do: buy the ring (watch) today or wait until next week?

Once again, taking into consideration your current situation, you will probably buy the item today and surprise your wife (husband) with a nice birthday present. It looks like the most rational choice would be to buy the ring (watch) today. Make happy and get on well with the people you love seem to be more satisfying than saving some money. We face once again the same questions: has your decision been emotionally biased and you are acting irrationally?

Rationality and Behavioural Sciences

From the behavioural economics perspective, these questions have two possible answers (at least): If we consider that rationality depends on a pure cognitive process and this process has been influenced by emotions (i.e., has been biased), then your attitude has been irrational. Even if you believe that you took the right decision/action, the behavioural account seems to indicate that you have acted irrationally. If we consider that rationality intrinsically depends on cognitive and affective processing, then your decisions/actions – to save the car and buy the item today – have been perfectly rational. In the decision-making process you also took into consideration your emotions. In fact, empirical sciences reveal that our decisions/actions in the previous examples are not biased at all. The motivation for this claim is that emotions are an intrinsic and inseparable component of the decision and rational choice [5, 6, 7].

From a psychological viewpoint, our decisions can be influenced by incidental or integral affects [7]. These effects can be either negative or positive. For instance, if we are in a bad mood because of a rainy day, we might decide not to buy the birthday present today. The mood, although unrelated to our decision-making process, can have a negative influence on our judgement. Thus, we decide to wait for a few days. Differently, integral affects are caused by the decision-making process itself. The joy of giving this present might play an important role in our decision. The emotional reaction influences your decision and induces us to buy the item.

From a neuroscientific point of view, the merging of cognitive and affective functions is striking. First of all, in the last decade empirical studies have shown that there is no clear distinction between an affective and a cognitive system. Cognitive processes are commonly performed by several interacting and interconnected (cognitive and affective) areas. More importantly, it appears that “there is no evidence for a single unified ‘system’ that drives emotion” [7, 220].

For instance, evidence shows that the amygdala, which has been traditionally considered as a brain structure responsible for emotions, is in fact responsible for both affective and cognitive processing and plays an essential role in decision making [2, 8, 9]. Second, an important number of studies show that brain damages in affectiveaffect structures (e.g., the amygdala) have detrimental consequences in rational behaviour. For instance, patients with amygdala damages experience a dramatically lower level of loss aversion than healthy people [9, 10]. Finally, signals from affective centres in the brain influence cognitive structures even before the decision-making process consciously occurs.

Findings in cognitive psychology and neuroscience provide nowadays good evidence to claim that rationality is not the result of a pure cognitive process but instead the result of an intimate and inseparable integration of both cognitive and affective processing.

Affective Biases

Notice that understanding rationality as the amalgamation of cognitive and affective processes sheds some light on how to understand biases [2, 4, 5]. Beneficial affective influences on decision making do not compose this category. Because “bias” has a negative meaning, only those affective influences which deviate the decision-making process from an appropriate (rational) outcome should be considered as affective biases.

But now we face another problem, if affects are part of rationality, how should we understand “affective biases”? An answer to this question can be found in Aristotle: a bias is a deviation from the mean towards two extremes.

In Nicomachean Ethics, Aristotle discussed moral virtues, what he called the “virtues of character” [11]. According to his description a virtue is a mean between two extremes, the vices. One of the main moral virtues explained by Aristotle is “courage”. Courage results from the mean between two extreme feelings, confidence and fear. For instance, a soldier is courageous if he can avoid the excess, i.e., recklessness or overconfidence, and the deficiency, i.e., cowardly. The excess will make him take unnecessary risks on the battlefield, and pay the consequences with his life. Differently, the deficiency will make him a coward, the fearful soldier will certainly run away from the battlefield.

The virtue (i.e. the right mean) is acquired through following the right habits. The mean is specific to each person, the right middle is not mathematically decided but depends on the person’s feelings and traits of character. For some people the mean is closer to the excess while for others it is closer to the deficiency.

A similar explanation can be applied to affective biases. They can be interpreted as the two (or more) extremes of a mean. For instance, a cautious investor is a person who learned how to find a right balance between confidence and fear. On the one hand, this investor will avoid being overconfident, he will not blindly trust his abilities but will be confident enough to reflect on his capacities and make judicious decisions. On the other hand, the cautious investor will be concerned with losses but he will not be fearful, that is, he will not have a loss-averse behaviour capable of damaging his financial decisions.

How can investors acquire the virtues of character? Perhaps, as Aristotle said, by following the right habits…



[1] Pompian, M. (2006): Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Biases, Wiley.

[2] Livet, P. (2010): “Rational Choice, Neuroeconomy, and Mixed Emotions”, Philosophical Transactions of the Royal Society, 36:138, 29–269.

[3] Mazzoli, C. and Marinelli, N. (2011): “The Role of Risk in the Investment Decision Process: Traditional vs Behavioural Finance”, in Lucarelli and Brighetti, eds., Risk Tolerance in Financial Decision Making, Palgrave Macmillan, ch. 1.

[4] Fairchild, R. (2014): “Emotions in the Financial Markets”, in Baker and Ricciardi, eds., Investor Behavior: The Psychology of Financial Planning and Investing, Wiley, ch. 19.

[5] Ackert, L. F., Church, B. K., and Deaves, R. (2003): “Emotion and Financial Markets”, Federal Reserve Bank of Atlanta Economic Review, 88:2, 33–41.

[6] Hytönen, K., Baltussen, G., van den Assem, M. J., Klucharev, K., Sanfey, A. G., and Smidts, A. (2014): “Path Dependence in Risky Choice: Affective and Deliberative Processes in Brain and Behavior”, Journal of Economic Behavior & Organization, 107, 66-81.

[7] Lempert, K. M. and Phelps, E. A. (2014): “Neuroeconomics of Emotion and Decision Making”, in Glimcher and Fehr, eds., Neuroeconomics: Decision Making and the Brain, Elsevier, 2nd ed., ch. 12.

[8] Vuilleumier, P. and Driver, J. (2007): “Modulation of Visual Processing by Attention and Emotion: Windows on Causal Interactions between Human Brain Regions”, Philosophical Transactions of the Royal Society B, 362, 837-8.

[9] Gupta, R., Koscik, T. R., Bechara, A., and Tranel, T. (2011): “The Amygdala and Decision-Making”, Neuropsychologia, 49, 760-766.

[10] De Martino, B., Camerer, C., and Adolphs, R. (2010): “Amygdala Damage Eliminates Monetary Loss Aversion”, PNAS, 107, 3788-3792.

[11] Aristotle: Nicomachean Ethics, Book III.
Ariel Cecchi

Ariel Cecchi

Research Associate at University College London (UCL)
Ariel Cecchi, Ph.D., is a research associate at University College London (UCL) and a consultant in Behavioural Finance.
Ariel Cecchi