Stress hormone linked to financial crisis

STRESS TRADINGThe stress that financial traders suffer during periods of high volatility in the markets reduces their appetite for risk, according to a study led by Cambridge university neuroscientist and former Wall Street trader John Coates. This may prolong financial crises.

The research, published in Proceedings of the National Academy of Sciences, combines field and lab work. Prof Coates and colleagues discovered that levels of the stress hormone cortisol increased by 68 per cent on average in a group of City of London traders over eight days in which market volatility increased.

 The scientists took this finding to Addenbrooke’s Hospital in Cambridge where they used pharmacology – hydrocortisone tablets – to raise cortisol levels in volunteers, also by 68 per cent over eight days. Participants then played an incentivised risk-taking game. The appetite for risk collapsed, by as much as 44 per cent according to one measure, in those with raised cortisol. (The study was double-blinded with a control group taking dummy tablets.)

Prof Coates believes the implications are important for the financial world. Subclinical stress affects people’s risk-taking behaviour, in a way that conventional metrics cannot detect. “There is a powerful physiological mechanism at work in the markets, and no one – not the traders, not the risk managers, not the policy makers – is aware of it,” he says.

The study also throws doubt on the assumption embedded in economics that risk preferences are stable. “This assumption, mostly hidden from view, underlies almost every economic model and, it turns out, every indicator of market sentiment,” Prof Coates says.

In fact individuals and companies tend to freeze up during crises, just when the markets offer the most attractive opportunities. During a financial crisis, the economy most needs risk takers but rising stress hormones contribute to the widespread risk aversion sometimes called irrational pessimism. “The stress response may thereby exacerbate market instability and prolong crises,” he concludes.