Higher levels of certain hormones make traders more likely to take financial risks—and they may even be making financial markets more unstable, a new study has found.
A study led by researchers from the University of Alicante in Spain and University College London found that high levels of testosterone and the cortisol lead investors—mostly men—to buy riskier assets, and they may contribute to price bubbles or other erratic behavior in financial markets. (Tweet This)
Both hormones occur naturally in the human body and are thought to influence a range of human behavior. Cortisol is associated with fear, among other things, and is thought to spike in the face of danger or uncertainty. Testosterone, the male hormone that's also found in small amounts in women, is connected to aggressive behavior, competition and confidence.
Earlier research has drawn tentative connections between these hormones and investment choices. For example, previous studies showed that higher levels of cortisol correlated with market uncertainty, and that higher levels of testosterone were correlated with higher trading profits. In the fields of finance and economics, researchers have drawn connections between emotions and investment decisions. Former Federal Reserve Chairman Alan Greenspan famously used the term "irrational exuberance" in 1996 to describe investor enthusiasm that pushes asset prices far above their fundamental value.
Until now, however, there's been little evidence for a direct, causal relationship between emotions and financial risk-taking. The Alicante/UCL team wanted to test if hormones actually influenced risk-taking behavior, rather than just accompany it.
They ran two experiments. In the first, the researchers took saliva samples from 142 male and female participants at the beginning of the study, analyzed hormone levels in it, and compared the data with the subjects' trading behavior in a simulated computer-based trading environment.
They found that hormone levels did affect financial decisions, but mostly among the men in the study. Testosterone had little impact on women's decisions, and cortisol seemed to make women slightly less likely to take risks, not more.
The team then gave a group of 75 young men doses of cortisol and testosterone and measured their trading decisions against a control group that received no hormone injections. They focused on males in the second half of the study in part because the men showed the strongest correlation in the first experiment, and in part because participation in financial markets is dominated by men, said Ed Roberts of University College London, one of the lead researchers on the study.
"We found that both cortisol and testosterone increased the amount of money participants were willing to invest in risky stocks," Roberts told CNBC. "Cortisol appears to increase risk-taking in a generalized way, whereas testosterone seems to act by changing predictions about future events. Essentially, after testosterone, the participants were more optimistic about future price increases, and subsequently invested more money in riskier stocks."
The team published its results Thursday in the peer-reviewed open access journal Scientific Reports.
Roberts told CNBC the simulated trading environment they created does not identically recreate real-life financial markets, but the researchers used real monetary incentives in their experiment, and there are other key similarities between their experiment and actual trading behavior.
"This study demonstrates that these hormones affect financial decision-making," Roberts said. He added that the challenge is for financial firms to find ways of minimizing the impact hormones have on risk-taking and on optimism.