Don’t blame Greenspan. Don’t blame the Fed. Don’t even blame Chuck Prince. Blame instead traders’ hypothalamus-pituitary-adrenal axes.
We had to read more of Cambridge research fellow John Coates’ paper, “Endogenous steroids and financial risk taking on a London trading floor”, published today in the Proceedings of the National Academy of Sciences.
Picture the scene: a City trading floor stuffed with untold screens and terminals, about 260 traders, of which 4 are women. So far, so standard. Less run-of-the-mill would have been the team of researchers taking saliva samples from 17 selected (male) traders twice daily.
The study looked at two hormones, testing levels of testosterone, associated with increased confidence, risk-taking and winning or losing, and cortisol, associated with stress and uncertainty. Elevated testosterone levels in the mornings were found to be predictive of a good P&L day for that trader - suggested a “winner effect”, where increased testosterone prompted greater appetite for risk and fearlessness augmenting performance.
Cortisol instead rose with the variance of a trader’s profits - and with implied volatility in the options market. The unusually volatile levels of the hormone observed were most pronounced in the most experienced traders, who appeared to be physiologically gearing up for an impending market move.
The trouble starts when these biological reactions move to the extremes. When testosterone becomes chronically elevated, the positive “winner effect” can tip over into impulsivity, sensation seeking and even euphoria and mania. Rising cortisol similarly might be helpful in increasing motivation and focusing attention, but persistently high levels can instead prompt anxiety and a tendency to see risk and threat where none exist.
In other words, forget the pro-cyclicality of Basle II. Here we have potential for a hormonal boom and bust.
Cortisol is likely, therefore, to rise in a market crash and, by increasing risk aversion, to exaggerate the market’s downward movement. Testosterone, on the other hand, is likely to rise in a bubble and, by increasing risk taking to exaggerate the market’s upward movement.
At the very least, the elevated levels of stress hormone cortisol, with some readings rising as much as 500 per cent during a trading day, might help to explain why the oldest trader on the floor had reached the grand age of 38, with the average came in at a youthful 27.6 years.
Related links
Traders should track their hormones - FT.com
