Financial crises can be made worse by the hormones of stressed bankers, a study suggests.
High levels of the stress hormone cortisol are likely to make traders risk-averse when the going gets tough, say researchers.
This is often just the time when the economy needs them to keep their nerve and start buying instead of selling or sitting put, it is claimed.
The new findings build on earlier research that showed a 68 per cent hike in cortisol levels among real City of London traders as market volatility increased over a period of two weeks.
In the latest study, involving volunteers playing a financial risk-taking game, a strong link was seen between higher cortisol and a drop in willingness to take risks.
Dr John Coates, a member of the Cambridge University research team and a former Wall Street derivatives trader, said: “Any trader knows that their body is taken on roller-coaster ride by the markets. What we haven’t known until this study was that these physiological changes – the sub-clinical levels of stress of which we are only dimly aware – are actually altering our ability to take risk.
“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.”
Cortisol, secreted by the adrenal glands, fuels the “fight or flight” response that evolved to aid survival in the face of physical threats, such as predators.
But cortisol levels also rise powerfully in non-physical stress situations including times of uncertainty.
Chronic high cortisol is linked to a host of health problems, including weakened immune function, reduced done density, weight gain, raised blood pressure, heart disease, anxiety and depression.
The new research suggests it is also strongly associated with risk aversion.
Participants in the study engaged in lottery-style financial risk-taking tasks with real monetary rewards. The aim was to measure the extent to which they were willing to take risks.
Over an eight day period, the volunteers – 20 men and 16 women aged 20 to 36 – were given an artificial form of cortisol that raised their levels of the stress hormone by 69 per cent, mimicking the increase seen previously in traders.
Initial spikes of cortisol had little effect on behaviour, but over time the willingness of participants to take risks fell dramatically.
The researchers observed a 44 per cent fall in the “risk premium”, the amount of extra risk a person will tolerate in the hope of higher returns.
There was no difference in risk averseness between men and women. However, when exposed to chronically high cortisol levels, men alone seemed to be fixated on smaller risks.
The scientists, whose findings appear in the journal Proceedings of the National Academy of Sciences, point out that during the Credit Crunch of 2007 to 2008 volatility in US equities peaked at more than 70 per cent.
Such historic market uncertainty would probably have caused traders’ stress hormones to rise higher than those seen in the study and for longer.
Chronic stress may have reduced risk-taking just when the economy needed it most, when markets were crashing and needed traders and investors to buy distressed assets, the authors claim.
Hormone-driven shifts in risk preferences may be a source of financial market instability that has been overlooked by economists and bankers, they add.
“Traders, risk managers, and central banks cannot hope to manage risk if they do not understand that the drivers of risk taking lurk deep in our bodies,” said Dr Coates, from the Cambridge Judge Business School.
“Risk managers who fail to understand this will have as little success as fire fighters spraying water at the tips of flames.”