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 emotionally biased, it means that the cognitive process has been influenced by feelings, affects, moods, and so on (let’s label these states “emotions”). This leads us to irrational decisions or actions. (Pompian 2006, Livet 2010, Mazzoli and Marinelli 2011, Fairchild 2014)

In this interpretation, cognitive and emotional processes are discrete and produced by two different systems: a cognitive and an emotional system. While cognitive biases are influences that affect rationality from within the cognitive system, emotional biases refer to those influences that affect 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 emotions. Emotions are so ubiquitous in our life and in every decision-making process that without them we would behave irrationally. What I will suggest in the following is that rationality is the consequence of the intrinsic and inseparable interaction between cognition and emotions rather than the result of an independent cognitive process influenced by the latter. As a matter of fact, this is the general understanding of rationality that many scientists vindicate. If that is true, the claim has important consequences for our understanding of both rationality and emotional biases.

Let me first introduce two examples to illustrate the role of emotions in our decisions. They will help to outline a commonsensical approach to rationality. Later, I will present some psychological and neuroscientific findings that support the claim that rationality is the result of an intimate interaction between cognition and emotions. Finally, I will suggest a way to understand emotional biases within this framework.

Suppose 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?

Well, according to traditional finance, you should maximise the utility of your actions, so you should save as many people as possible. Your rational choice should be to save the bus. Differently, according to the behavioural approach, your decision will be biased by emotions and you will certainly save the member of your family. From this perspective, it seems clear that the most rational scenario 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 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: Let’s imagine a less tragic example. 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 you normally like to do. 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, according to traditional finance you should maximise your utility and wait until next week. But taking into consideration the general situation and according to behavioural finance’s predictions, you will probably buy the item today and surprise your wife (husband). It looks like the most rational choice would be to buy the ring (watch) today – making the people you love happy and get on well with them is more satisfying than saving some money. We face once again the same questions: has your decision been emotionally biased and are you acting irrationally?

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 emotional 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 appear to show 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 our decisions and rational choices (Ackert et al. 2003, Hytönen et al. 2014, Lempert and Phelps 2014).

From a psychological viewpoint, emotions have important effects on decision making. Emotions can influence decisions indirectly. That is, the affective response can be incidental to the choice options: this influence indirectly affects the subjective value attributed to some option. For example, if in a group of options, one of them elicits a fear reaction, this feeling will contribute to a negative assessment of that option. As a consequence, the subjective value attributed to this option would be negative and the option’s significance will be overlooked. The emotional influence in decisions can be also direct. The emotional reaction does not need to affect the subjective value of a choice option but rather it can become incorporated into the calculation as an option in itself. (Lempert and Phelps 2014) To put it otherwise, imagine a logic argument in which you have a conclusion that follows from a number of premises. In the indirect case, the emotional reaction influences the subjective value of some of the premises (perhaps, making them more or less desirable). In the direct case, the emotional response becomes one of the premises (e.g., an emotional physiological response) from which the conclusion follows. In addition, emotions can act as triggers of other mental states (stored memories, new beliefs, new preferences, and the like) that could be included as premises in the argument leading to a particular decision.

From a neuroscientific point of view, the merging of cognitive and emotional functions is striking. First of all, in the last decade empirical studies have shown that there is no clear distinction between an emotional and a cognitive system. Cognitive processes are commonly performed by several interacting and interconnected (cognitive and emotional) areas. More importantly, it appears that “there is no evidence for a single unified ‘system’ that drives emotion” (Lempert and Phelps 2014, 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 emotional and cognitive processing and plays an essential role in decision making (Vuilleumier and Driver 2007, Livet 2010, Gupta et al. 2011). Second, an important number of studies show that brain damages in emotional 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 (De Martino et al. 2010, Gupta et al. 2011). 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 sufficient 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 emotional processing.

Notice that understanding rationality as the amalgamation of cognitive and emotional processes sheds some light on how to understand biases which are regarded sometimes as beneficial and sometimes as detrimental (Ackert et al. 2003, Livet 2010, Fairchild 2014). We should not consider beneficial biases as such (the definition of “bias” has a negative meaning) but rather as an intrinsic emotional process of rationality. Emotional biases should be regarded as deviations, that is, those emotional influences which deviate the decision-making process from an appropriate (rational) outcome.

But now we face another problem, if emotions are part of rationality, how should we understand “emotional 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”. According to his description a virtue is a mean between two extremes, the vices. One of the main moral virtue 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 emotional biases. Emotional biases 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…



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.

Aristotle: Nicomachean Ethics, Book III.

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

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.

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

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, 566-581.

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.

Livet, P. (2010): “Rational Choice, Neuroeconomy, and Mixed Emotions”, Philosophical Transactions of the Royal Society, 365:1538, 259–269.

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.

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

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, 837-855.

Ariel Cecchi

Ariel Cecchi

Consultant on Behavioural Economics and Service Design
Ariel Cecchi is a consultant on behavioural economics and service design. He holds a PhD in epistemology and philosophy of cognitive neuroscience from the University of Geneva. He was also a visiting research fellow at the University of Glasgow. His doctoral research focused on understanding how cognitive and emotional influences affect human perception and how individuals know the world around them.
Ariel Cecchi
Ariel Cecchi

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