According to a team of researchers from Cambridge University, surging hormone levels were partly responsible for the current financial crisis - because they encouraged traders to take irrational risks in a soaring market.
The researchers found traders’ steroid levels (particularly testosterone and cortisol) soared when they made a bigger profit than usual; this ‘winner effect’ (which is also seen in top sportspeople) increased their confidence and made them more willing to take risks. In the short term, this often meant they were more likely to make a bigger profit – but after a while it also affected their ability to take rational decisions.
‘Rising levels of testosterone and cortisol prepare traders for taking risk,’ explains the report’s author Dr. John Coates. ‘However, if testosterone reaches physiological limits, as it might during a market bubble, it can turn risk-taking into a form of addiction, while extreme cortisol during a crash can make traders shun risk altogether.’ So either you become incapable of doing anything at all, or you start racking up losses on a Nick Leeson/ Jerome Kerviel scale.
This also means the impact of hormones can exaggerate any big swings in the market. When there’s a bubble developing, testosterone surges – so traders are more inclined to take risks and thus push the market even higher. But when the market is falling, cortisol levels rise – encouraging inertia and making the downturn more severe. Coates talks about traders entering a state of ‘learned helplessness’ – perhaps why central bank intervention isn’t always enough to revive the market. ‘At times like these economics has to consider the physiology of investors, not just their rationality,’ he said learnedly.
We’re guessing this won’t be much consolation to the 40,000 City workers likely to lose their jobs as a result of the current crisis, according to the latest estimate from analysts at JP Morgan. But it does perhaps help to explain how such a vast amount of money managed to get lost in these financial black holes (though we’re guessing that US physicist John Wheeler, the man who coined the term ‘black hole’ and died at the weekend, probably never expected it to be used in connection with sub-prime CDOs).
Perhaps the City trading floors need to start putting a bit of oestrogen in their watercoolers....