Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

Stress hormones in traders may trigger 'risk aversion' and contribute to market crises

18.02.2014
High levels of the stress hormone cortisol may contribute to the risk aversion and 'irrational pessimism' found among bankers and fund managers during financial crises, according to a new study.

The study's authors say that risk takers in the financial world exhibit risk averse behaviour during periods of extreme market volatility – just when a crashing market most needs them to take risks – and that this change in their appetite for risk may be "physiologically-driven", specifically by the body's response to cortisol. They suggest that stress could be an "under-appreciated" cause of market instability.

Published today in the journal Proceedings of the National Academy of Sciences, the study conducted at the Cambridge Judge Business School and the Department of Medicine's Institute of Metabolic Science is the first to show that personal financial risk preferences fluctuate substantially, and these fluctuations may be linked to hormone response.

The finding could fundamentally alter our understanding of risk as, up until now, almost every model in finance and economics – even those used by banks and central banks – rested on the assumption that traders' personal risk preferences stay consistent across the market cycle, say the authors.

In a previous study conducted with real traders in the City of London, researchers observed that cortisol levels rose 68% over a two week period when market volatility increased. In the latest study they combined field work with lab work, a rare approach in economics, to test for the effects of this elevated cortisol on financial risk-taking.

The researchers administered hydrocortisone – the pharmaceutical form of cortisol – to 36 volunteers, 20 men and 16 women, aged 20 to 36 years, over an eight day period, raising their cortisol levels 69%: almost exactly the levels seen in the traders.

The volunteers took part in lottery-style financial risk-taking tasks with real monetary pay-offs, designed to measure the preferences for risky gambles and the judgments of probability underlying their risk taking. While initial spikes of cortisol had little effect on behaviour, chronically high and sustained levels, as seen in traders, led to a dramatic drop in participants' willingness to take risks, with the 'risk premium' – the amount of extra risk someone will tolerate for the possibility of higher return – falling by 44%.

"Any trader knows that their body is taken on rollercoaster ride by the markets. What we haven't known until this study was that these physiological changes - the sub-clinical levels of stress of which we are only dimly aware - are actually altering our ability to take risk," said Dr John Coates, co-lead of the study from the Cambridge Judge Business School, and a former Wall Street derivatives trader himself.

"It is frightening to realize that no one in the financial world – not the traders, not the risk managers, not the central bankers – knows that these subterranean shifts in risk appetite are taking place."

Cortisol is a hormone secreted by the adrenal glands in response to moments of high physical stress, such as 'fight or flight'. Importantly, cortisol also rises powerfully in situations of uncertainty, such as volatility in the financial markets. Cortisol prepares us for possible action by releasing glucose and free fatty acids into the blood. It also suppresses any bodily functions not needed during a crisis - such as the digestive, reproductive, and immune systems.

However, should this stress become chronic, as it might during a prolonged financial crisis, the elevated cortisol can contribute to impaired learning, heightened anxiety, and eventually depression. The current study has now shown that in addition to these known pathologies, chronic stress can also lead to a substantial decrease in the willingness to take financial risks, say the researchers.

They also suggest that an unsuspected side effect of anti-inflammatory treatments such as prednisone may be financial risk aversion.

The study's authors also looked for differences between men and women. While other researchers have argued that women are more risk averse than men, the current study found no differences between the sexes under normal circumstances. However, the study did find that, when exposed to chronically-raised levels of cortisol, men placed too much importance on smaller risks, while women did not.

The authors point out that during the Credit Crisis of 2007 to 2009 volatility in US equities spiked from 12% to over 70%. They argue that it is reasonable to assume that such historically high levels of uncertainty would have caused stress hormones to rise far higher and longer than the team had been able to observe in their study.

Chronic stress may therefore have decreased risk taking just when the economy needed it most – when markets were crashing and needed traders and investors to buy distressed assets, they say. Physiologically-driven shifts in risk preferences may be a source of financial market instability that hasn't been considered by economists, risk managers and central bankers alike.

Added Coates: "Traders, risk managers, and central banks cannot hope to manage risk if they do not understand that the drivers of risk taking lurk deep in our bodies. Risk managers who fail to understand this will have as little success as fire fighters spraying water at the tips of flames."

Fred Lewsey | EurekAlert!
Further information:
http://www.cam.ac.uk

More articles from Studies and Analyses:

nachricht The personality factor: How to foster the sharing of research data
06.09.2017 | ZBW – Leibniz-Informationszentrum Wirtschaft

nachricht Europe’s Demographic Future. Where the Regions Are Heading after a Decade of Crises
10.08.2017 | Berlin-Institut für Bevölkerung und Entwicklung

All articles from Studies and Analyses >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: Highly precise wiring in the Cerebral Cortex

Our brains house extremely complex neuronal circuits, whose detailed structures are still largely unknown. This is especially true for the so-called cerebral cortex of mammals, where among other things vision, thoughts or spatial orientation are being computed. Here the rules by which nerve cells are connected to each other are only partly understood. A team of scientists around Moritz Helmstaedter at the Frankfiurt Max Planck Institute for Brain Research and Helene Schmidt (Humboldt University in Berlin) have now discovered a surprisingly precise nerve cell connectivity pattern in the part of the cerebral cortex that is responsible for orienting the individual animal or human in space.

The researchers report online in Nature (Schmidt et al., 2017. Axonal synapse sorting in medial entorhinal cortex, DOI: 10.1038/nature24005) that synapses in...

Im Focus: Tiny lasers from a gallery of whispers

New technique promises tunable laser devices

Whispering gallery mode (WGM) resonators are used to make tiny micro-lasers, sensors, switches, routers and other devices. These tiny structures rely on a...

Im Focus: Ultrafast snapshots of relaxing electrons in solids

Using ultrafast flashes of laser and x-ray radiation, scientists at the Max Planck Institute of Quantum Optics (Garching, Germany) took snapshots of the briefest electron motion inside a solid material to date. The electron motion lasted only 750 billionths of the billionth of a second before it fainted, setting a new record of human capability to capture ultrafast processes inside solids!

When x-rays shine onto solid materials or large molecules, an electron is pushed away from its original place near the nucleus of the atom, leaving a hole...

Im Focus: Quantum Sensors Decipher Magnetic Ordering in a New Semiconducting Material

For the first time, physicists have successfully imaged spiral magnetic ordering in a multiferroic material. These materials are considered highly promising candidates for future data storage media. The researchers were able to prove their findings using unique quantum sensors that were developed at Basel University and that can analyze electromagnetic fields on the nanometer scale. The results – obtained by scientists from the University of Basel’s Department of Physics, the Swiss Nanoscience Institute, the University of Montpellier and several laboratories from University Paris-Saclay – were recently published in the journal Nature.

Multiferroics are materials that simultaneously react to electric and magnetic fields. These two properties are rarely found together, and their combined...

Im Focus: Fast, convenient & standardized: New lab innovation for automated tissue engineering & drug

MBM ScienceBridge GmbH successfully negotiated a license agreement between University Medical Center Göttingen (UMG) and the biotech company Tissue Systems Holding GmbH about commercial use of a multi-well tissue plate for automated and reliable tissue engineering & drug testing.

MBM ScienceBridge GmbH successfully negotiated a license agreement between University Medical Center Göttingen (UMG) and the biotech company Tissue Systems...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

Event News

“Lasers in Composites Symposium” in Aachen – from Science to Application

19.09.2017 | Event News

I-ESA 2018 – Call for Papers

12.09.2017 | Event News

EMBO at Basel Life, a new conference on current and emerging life science research

06.09.2017 | Event News

 
Latest News

Comet or asteroid? Hubble discovers that a unique object is a binary

21.09.2017 | Physics and Astronomy

Cnidarians remotely control bacteria

21.09.2017 | Life Sciences

Monitoring the heart's mitochondria to predict cardiac arrest?

21.09.2017 | Health and Medicine

VideoLinks
B2B-VideoLinks
More VideoLinks >>>