New study links financial risk tolerance to hormonal fluctuations brought on by stress
There are myriad of risk tolerance tools that financial professionals use to measure their clients’ appetite for risk. Among them, Ameriprise Financial, Merrill Lynch, and Charles Schwab all take old-school approaches to assessing client risk tolerance. Meanwhile, United Capital is one of the financial institutions that has taken a more innovative approach to risk tolerance with their Find Your Money Mind™ tool.
Amazingly enough, the risk tolerance of the financial professional is rarely questioned or measured — despite the fact that their view on risk has a significant impact on their investment allocation recommendations.
As a portfolio manager or investment advisor, it’s worth asking: Have I lost my appetite for risk? If so, that might not be a good thing—especially for those who need to be able to rationally set risk tolerances to optimize opportunity. Well, research by Cambridge Judge Business School and the University of Cambridge’s Institute of Metabolic Science casts new light on how financial professionals tolerate risk, and it might have more to do with hormones than financial modeling or reasoned thought.
The study looked at the 36 London traders—16 women and 20 men—and found a 68 percent increase in daily cortisol levels (an indicator of stress) during volatile markets. That swing is even higher than stress brought on by surgery or trauma of some sort.
The researchers then ran a double blind test—feeding some of the volunteer traders with placebos and others with a pill form of the stress hormone over an eight-day period. During the study, the subjects could win cash by playing a computer game. As the regimen continued and the amount of cortisol increased in those who actually received the hormone, those traders took less and less risk when playing the game.
The implications are startling considering, as the authors of the study note, that risk taking is a fundamental driver of financial markets. Most economic models assume that risk tolerances are static—set rationally and that market participants react according to these set tolerances based on changes in market conditions.
But this new study suggests that trader’s own hormone levels can change risk tolerances—upsetting the long-held assumptions about the market’s inner workings.