Hormonal Male Traders producing a Momentum Effect contrary to the Efficient Market Hypothesis and Rational Choice

By HopeForTheDismalScience (William P Bell)

Coates and Herbert (2008) study the role of the endocrine system in financial risk taking in a group of male traders in London. They find a positive relationship between a trader’s testosterone level and his daily Profit and Loss (P&L) and between his cortisol level and financial uncertainty, being measured by variance of economics returns and expected variance of the market. They note that rational choice is affected by the levels of the hormones. The more profits the trader made relative to his daily average the higher his testosterone became. Heightened testosterone increases a trader’s preference for risk. The process has a positive feedback, producing a financial variant of the “winner effect”. Additionally, short periods of high volatility increase a trader’s cortisol levels, which increase his motivation and his ability to focus, producing a euphoric feeling. However, prolonged period of elevated cortisol levels produce selective attention on mostly negative events and anxiety, reducing a trader’s preference for risk. Even if the number of traders is small, these hormonal effects could reinforce the momentum effect and cause markets to deviate from rational choice.

Reference

Coates, JM & Herbert, J 2008, ‘Endogenous steroids and financial risk taking on a London trading floor’, Proceeding of the National Academy of Science of the USA, vol. 105, no. 16, pp. 6167-72.

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