Endocrine Abstracts

The financial markets represent the largest and most intense competitive forum ever constructed. Here, according to classical economic theory, competition drives optimal allocation of capital to projects with the highest returns, thereby promoting global prosperity. However, financial markets can be volatile, cycling between ‘bull’ and ‘bear’ states, and threatening the stability of the global economy.

Bull markets can morph into bubbles, in which investors display ‘irrational exuberance’ (an unrealistic assessment of expected returns); in contrast, bear markets may segue into financial crises, in which investors display ‘irrational pessimism’ (an almost complete aversion to risk). During bubbles and crashes investors react to price changes in a manner which is precisely the opposite to what economics would predict: the higher securities’ prices rise, the more investors buy them; the lower prices fall, the more investors shun them.

We have examined the potential for physiology-induced shifts in risk preferences to influence market stability on the world’s trading floors. Our findings show that when uncertainty, represented by market volatility, increases, traders experience a sustained increase in cortisol levels. Using a double-blind placebo-controlled cross-over design, in volunteers who were incentivised to make financial choices, we have shown that a comparable, modest rise in cortisol levels is sufficient to render individuals significantly more risk averse. Our findings point to an alternative model of risk taking in which risk preferences are not stable, but highly dynamic. Such a model might explain why the risk premium on equities rises and falls with volatility, and why the appetite for risk among the financial community expands during a rising market, and contracts during a declining one. Critically, if cortisol responds to increases in uncertainty and volatility, and volatility rises during a financial crisis, then risk taking may decrease just when the economy needs it most.