It is frightening to realise 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
- John Coates
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 in the journal Proceedings of the National Academy of Sciences, the study conducted at the Cambridge Judge Business School and the University’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.
Read the full story
Image:That was supposed to be going up, wasn't it?
Credit: Rafael Matsunaga via Flickr
Reproduced courtesy of the University of Cambridge
________________________________________