Abstract
It is widely known that financial markets can become dangerously unstable, yet it is unclear why. Recent research has highlighted the possibility that endogenous hormones, in particular testosterone and cortisol, may critically influence traders’ financial decision making. Here we show that cortisol, a hormone that modulates the response to physical or psychological stress, predicts instability in financial markets. Specifically, we recorded salivary levels of cortisol and testosterone in people participating in an experimental asset market (N = 142) and found that individual and aggregate levels of endogenous cortisol predict subsequent risk-taking and price instability. We then administered either cortisol (single oral dose of 100 mg hydrocortisone, N = 34) or testosterone (three doses of 10 g transdermal 1% testosterone gel over 48 hours, N = 41) to young males before they played an asset trading game. We found that both cortisol and testosterone shifted investment towards riskier assets. Cortisol appears to affect risk preferences directly, whereas testosterone operates by inducing increased optimism about future price changes. Our results suggest that changes in both cortisol and testosterone could play a destabilizing role in financial markets through increased risk taking behaviour, acting via different behavioural pathways.
Highlights
Predict success rates and confidence in competitive encounters with levels increasing in response to victories[16,17] or challenging situations, thought to be part of a positive feedback loop termed the ‘winner effect’[18,19]
If altered levels of either hormone were to affect the appetite for financial risk, could this in turn destabilize the market as a whole? Since the fundamental value of an asset in a financial market is an aggregation of the stochastic stream of future dividends, trading at prices higher than the fundamental value is only profitable when there is a widespread belief that other traders will continue to buy at prices even further away from fundamental values
Research in the behavioural sciences has long highlighted the important influence of hormonal variations in a wide variety of behaviours, yet their role in economic decision making has only begun to be examined
Summary
Predict success rates and confidence in competitive encounters with levels increasing in response to victories[16,17] or challenging situations, thought to be part of a positive feedback loop termed the ‘winner effect’[18,19]. The evidence would seem to indicate that either hormone could play a role in modulating individual preferences for risk taking and market instability, when participating in an arena as stressful and competitive as a modern financial market This possibility is supported by data from field investigations examining the hormone levels of professional traders. We first tested the hypothesis that endogenous levels of either cortisol or testosterone would predict risk taking and price instability in a well-understood experimental trading environment that mimics the key features of a real-world financial market. We were interested in whether elevated levels of testosterone or cortisol increased preferences for investing in risky rather than safe assets
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