Hormones flood our bodies—and brains—at moments of stress. Does that make financial markets irrational?by John Coates / June 20, 2012 / Leave a comment
Published in July 2012 issue of Prospect Magazine
When you take risks, you are reminded in the most insistent manner that you have a body. For risk, by its very nature, threatens to hurt you.
A driver speeding along a winding road, a surfer riding a monster wave as it crests over a coral reef, a soldier sprinting across no-man’s land—each of these people faces a high chance of injury, even death. And that very possibility sharpens the mind and calls forth an overwhelming biological reaction known as the “fight-or-flight” response. In fact, so sensitive is your body to the taking of risk that you can be caught up in this visceral turmoil even when death poses no immediate threat. Winston Churchill, a hardened military campaigner, recognised this power of non-lethal risk to grip us. When writing of his early years, he tells of a regimental polo match played in southern India that went to a tie-break in the final chukka: “Rarely have I seen such strained faces on both sides,” he recalled. “You would not have thought it was a game at all, but a matter of life and death. Far graver crises cause less keen emotion.”
Similar strong emotions and biological reactions can be triggered by another form of non-lethal risk: financial risk-taking. Professional traders, asset managers and investors rarely face death in their dealings; but the bets they place can threaten their job, house, marriage, reputation and social class. In this way money holds a special significance in our lives, so making and losing it can activate a powerful biological response.
This statement about biology and the financial markets may sound strange to ears accustomed to the teachings of economics. Economists tend to view the assessment of financial risk as a purely cognitive affair, requiring the calculation of asset returns, probabilities, and the optimal allocation of capital. But to this bloodless account of decision-making I want to add some biology. For recent advances in neuroscience and physiology have shown that…