The Stress-Response Costs in Decision Making

Incoming information brings in news which could be neutral, good, or bad. However, the brain and the body’s response to bad news is much stronger and sustained. Bad news may trigger the human stress-response system which creates a chemical bath in both the brain and the body. In particular, the stress hormone, cortisol, is released, which provides a quick boost of energy to the body and the brain. However, repeated or continuous exposure to cortisol exacts substantial costs on both the brain and the body. We argue that it is implausible to assume that the brain, which ultimately is the seat of all decision-making, completely ignores all such costs. In this article, we show that the inclusion of such costs provides a unified explanation for the Allais paradox and the Ellsberg paradox and makes predictions that are empirically supported. We further show that such costs potentially contribute to high and countercyclical equity-premia.