Testosterone, Cortisol and Market Behavior

Nature News is reporting on a paper that just came out in PNAS. The paper, Coates and Herbert, correlates the daily profits and trading volatility of traders in London. They argue that changes in these hormone may be responsible for changes in trader profits and market volatility.

Let's file this paper under "wildly over-interpreted" because there are some big caveats that you have to remember before you can make a claim anything like that.

Coates and Herbert measured morning levels of testosterone and daily levels of cortisol (average of two measurements) in 17 male traders in the City of London over 8 days of trading. Let's set aside for the time being whether 17 traders over 8 days is a big enough data set. Let's also set aside whether salivary testosterone correlates well with testosterone in the brain. (Testosterone metabolism is complicated, and I don't have time to go into that.)

They have two key findings shown in the figures below.

Their first big finding was that morning testosterone correlated with the size of profits for the day. They segregated the traders each day into a high and low testosterone group, and the relation to profit is shown below. Note that an individual trader might be in the high group one day and the low group another day. (Below is Figure 2 from the paper.)

Their second big finding was that daily cortisol (the average of a morning and an afternoon measurement) correlated with market volatility. (Below is Figure 4 from the paper.)

I am not surprised by either of those findings. Testosterone has been shown to rise in runner's who win races and fall in runner's who lose races -- the so-called winner's effect. Cortisol is a stress hormone, and it isn't unreasonable to expect it the trader's to respond to market volatility by being stressed.

However, the authors seem to want to interpret that these two hormones are causal for market bubbles -- or at least one of them does. Nature News reports:

The results, appearing today in the Proceedings of the National Academy of Sciences 1, were clear according to Coates: "Traders had an above-average gain on the days their testosterone was above average." In 14 out of the 17 cases, the traders earned more money on days they had elevated morning levels of the hormone.

Was the testosterone behind the winnings? Coates thinks so. But co-author Herbert cautions that the results aren't strong enough to prove that testosterone is driving risky behaviour: "It remains a correlation, not a causation," he says.

Levels of cortisol, on the other hand, appeared not to correlate with winning or losing. Rather, the hormone seemed to track with the volatility of the market itself, a factor which may have made traders' days more stressful. (Emphasis mine.)

While I am frankly a little puzzled about how the two co-authors would differ on an important interpretive detail, I am going to stick with what they actually said in their discussion section. Here is how they interpret their results:

When traders in our study experienced acutely raised testosterone, for example, they made higher profits, perhaps because testosterone has been found, in both animal and human studies, to increase search persistence (20), appetite for risk (21), and fearlessness in the face of novelty (22, 23), qualities that would augment the performance of any trader who had a positive expected return. However, if testosterone continued to rise or became chronically elevated, it could begin to have the opposite effect on P&L and survival (24), because testosterone has also been found to lead to impulsivity and sensation seeking (25), to harmful risk taking (21), and, among users of anabolic steroids, to euphoria and mania (26). In one study, testosterone was administered to a group of subjects playing the Iowa Gambling
Task, and it led to irrational risk-reward tradeoffs, causing the subjects to prefer the high-variance negative expected-return decks of cards to the low-variance positive expected-return decks (27, 28). It has also been found that testosterone and its metabolite, 3alpha-androstanediol, have rewarding and addictive properties, largely because they increase dopamine release in the shell of the nucleus accumbens (29, 30), a brain region found to be stimulated in anticipation of irrational risk seeking (16). Testosterone may therefore underlie a financial variant of the ''winner effect,'' in which a previous win in the markets leads to androgenic priming and increased (and eventually irrational) risk taking in the next round of trading. This effect, even if confined to a small number of people, could cause financial markets to deviate from the predictions of rational choice theory (31).

Rising cortisol could also affect a trader's risk preferences but in the opposite direction to testosterone. During our study, traders experienced acutely raised cortisol in anticipation of higher volatility and the increased chances of making money that higher volatility brings. Cortisol (along with other glucocorticoids such as corticosterone) is known to have powerful cognitive and emotional effects. These effects depend on the amount of steroid reaching the brain, the duration of the exposure, and the timing of the exposure relative to the event that is to be learned or remembered (32). If exposure is acute, glucocorticoids can be euphorogenic, increasing motivation and promoting focused attention. They can also aid the consolidation and retrieval of important memories (6, 7). However, if elevated glucocorticoids persist, their effects can be debilitating. During times of chronic stress, glucocorticoids, acting through the amygdala and hippocampus, promote a selective attention to mostly negative precedents (6); stimulate corticotrophin-releasing hormone (CRH) gene expression in the central nucleus of the amygdala and consequent feelings of anxiety (33); and produce a tendency to find threat and risk where none exist (34). Together, these effects would tend to decrease a trader's risk taking. A situation of chronically elevated cortisol might occur if financial market volatility were to rise for an extended period, something that normally happens when the economy receives an unwelcome shock or enters a depression (35).

Cortisol is likely, therefore, to rise in a market crash and, by increasing risk aversion, to exaggerate the market's downward movement. Testosterone, on the other hand, is likely to rise in a bubble and, by increasing risk taking, to exaggerate the market's upward movement. These steroid feedback loops may help explain why people caught up in bubbles and crashes often find it difficult to make rational choices.(Emphasis mine.)

I have a big problem with the interpretation that these hormones are causal for financial depressions and volatility. There are several reasons to view these correlations with stress hormones with considerable interpretative caution.

First, the authors have a timing problem. While they are measuring acute changes in hormone concentration, the mechanism that they posit for escalating financial instability relies on chronic changes in hormone levels. In no way was this paper designed to measure chronic changes. They only sampled for 8 days. Furthermore, I want to understand the molecular mechanism that they are pushing here. Steroid hormones like cortisol and testosterone generally act by binding to intracellular receptors and triggering changes in protein production. This is not a quick process. You could probably argue that a day is enough to see changes, but the duration of action is likely much longer.

Second, testosterone's effects on behavior are like a billion times more complicated than they are making it sound. Take the much touted association between testosterone and aggression. True, in castrated animals and hypogonadal humans aggression does go down. True, in humans and animals with supraphysiological doses of testosterone aggression does go up -- in humans this is called roid rage. However, these findings belie the complexity of the system. Within the normal physiological range of testosterone for adult males, testosterone levels do not correlate well with aggression. The results are quite mixed. (For further reading on the subject, the best source is a book by one of my college professors, Robert Sapolsky's The Trouble with Testosterone. Here is a more current review.) Further, expression of aggressive behavior as a response to testosterone is modified by like 16 other things including cortisol. The point I am making by analogy is drawing a causal line between testosterone concentrations in the physiological range and any behavior is notoriously difficult to prove.

Third, I take specific issue with using results in the Iowa Gambling Task to explain an increase in profits. The Iowa Gambling Task tests the rate at which players switch between a high payoff/negative expected return deck and a low payoff/positive expected return deck. Good performance on the IGT is interpreted as a willingness to flexibly adapt behavior and to appropriately assess long-term expected reward. Poor performance is interpreted as perseveration on a bad strategy or failure to accurate measure long-term rewards. Even if the association between testosterone and picking the high variance deck in the IGT is real, why would high variance seeking behavior imply higher profit? Wouldn't imply less profit or higher volatility? I can think of a lot of traits that make for a consistently profitable day-trader, but volatility and inflexibility are not among them.

Third, with respect to the cortisol, I have a dosage and a complexity issue. The dose of the cortisol that causes euphoria and long-term changes in brain structure is -- as I understand it -- quite high and chronic. Being a trader might be that stressful, but that is something you have to check. Further, the changes in behavior and brain structure in response to stress are also incredibly complicated. They are highly dependent on individual differences as well the amount of stress that the animal/human has experienced in the past. (The authority on this is Bruce McEwen. Here is a review by him.) I find it difficult to accept the suggestion that increased cortisol within the physiological range would have any predictable consequences in market behavior. Some people would respond better in the stressful circumstances, some would respond worse, and some would respond not at all; and in all three cases the effects of cortisol would be modified or mitigated by ten other hormones acting on different time scales. Also, an economist might ask how much of a critical mass of individuals would have to be responding in the same way to create a market bubble. I imagine a lot.

Taking all these caveats into mind, I remain skeptical that this finding is anything other than an interesting correlation. In order to prove me wrong, they would have to perform a much longer survey associating this hormones with market behavior. They would also have to demonstrate that the doses of hormonese they are observing cause significant and consistent changes in behavior. They haven't done either of those things.

Coates, J.M., Herbert, J. (2008). Endogenous steroids and financial risk taking on a London trading floor. Proceedings of the National Academy of Sciences DOI: 10.1073/pnas.0704025105