SOAS Research Online

Abstract

Risk taking is central to human activity. Consequently, it lies at the focal point of behavioral sciences such as neuroscience, economics, and finance. Many influential models from these sciences assume that financial risk preferences form a stable trait. Is this assumption justified and, if not, what causes the appetite for risk to fluctuate? We have previously found that traders experience a sustained increase in the stress hormone cortisol when the amount of uncertainty, in the form of market volatility, increases. Here we ask whether these elevated cortisol levels shift risk preferences. Using a double-blind, placebo-controlled, cross-over protocol we raised cortisol levels in volunteers over 8 d to the same extent previously observed in traders. We then tested for the utility and probability weighting functions underlying their risk taking and found that participants became more risk-averse. We also observed that the weighting of probabilities became more distorted among men relative to women. These results suggest that risk preferences are highly dynamic. Specifically, the stress response calibrates risk taking to our circumstances, reducing it in times of prolonged uncertainty, such as a financial crisis. Physiology-induced shifts in risk preferences may thus be an underappreciated cause of market instability. Risk is inescapable. We take risks whenever we play a sport, enter a personal relationship, or choose a career. In the financial sector, the appetite for—and skill at—risk taking among those working on the world’s trading floors affects the stability of the market, the growth of the economy, and, through these effects, the health and well-being of the wider population. A scientific understanding of risk-taking behavior is therefore of pressing concern for individual investors, managers of financial institutions, and policy makers alike. To address this concern, decision sciences such as economics and finance have placed risk taking at the very heart of their research agendas. Historically, many of these sciences have built theories upon the assumption that people make consistent choices based on relatively stable preferences through time. Such an assumption leads to transitive (i.e., noncontradictory, and therefore rational) choices and permits the building of models that are tractable and elegant. This assumption of stable risk preferences has been widely influential in economics and finance (1⇓–3), and its influence has extended into certain branches of biology, such as evolutionary game theory (4). However, is this assumption justified? Are our risk preferences indeed stable? Since the financial crisis of 2007–2009, evidence has suggested they are not. For example, a small number of empirical studies have shown that financial risk preferences do fluctuate (5). In addition, anecdotal evidence suggests that traders and investors experience a greater willingness to take risks during a rising market and a reduced willingness during a falling one. If risk preferences do indeed move in tandem with the market cycle, they may exaggerate the peaks and troughs, thereby contributing to financial instability. What physiological mechanisms could cause risk preferences to fluctuate in this manner? The hormone cortisol, a glucocorticoid produced by the adrenal glands and one of the main stress hormones, might play a particularly important role here, because circulating levels of this hormone increase in situations of novelty, uncertainty, and uncontrollability (6⇓–8). When in a novel environment or a state of uncertainty we do not know what to expect, and rising levels of cortisol help us marshal a preparatory stress response. The financial markets present a unique venue for conducting controlled studies of uncertainty and stress because uncertainty in this setting can be quantified precisely: The greater the uncertainty, the greater the volatility, measured objectively by the variance in securities prices. In a previous study we examined the effects of market volatility on a group of traders in the City of London and found that as volatility increased over an 8-d period the traders experienced a 68% increase in their mean daily cortisol levels (9). An important question emerged from this fieldwork: Does the increase in cortisol stemming from market uncertainty in itself affect risk preferences? If so, do the effects of hypercortisolism differ between an acute (short-lived, i.e., minutes to hours) and a chronic (sustained, i.e., days to weeks) exposure? Acute and chronic exposures to cortisol can have very different, and in many cases opposite, effects. Acute cortisol elevation has been found to increase physical arousal (10), aid in the recall of important memories (11), and, by interacting with dopaminergic pathways in the brain, promote learning, motivated behavior, and sensation seeking (12⇓–14). Taken together these observations might suggest that an acute exposure to cortisol could promote risk taking, although there is only a limited amount of literature to support this contention (13, 14). By contrast, longer-term exposure to raised cortisol levels, as one might experience during periods of sustained uncertainty, can impair many physiological responses. For example, it can contribute to metabolic dysfunction (15) and immunological impairment (16); in the brain, it can impair attentional control and behavioral flexibility (17⇓–19), and it can promote anxiety (20), depression (21), and learned helplessness (22). These latter effects could be expected to discourage risk taking. We therefore developed the hypothesis that whereas an acute exposure to raised cortisol levels would have either no significant effect or, at most, modest ones on promoting risk taking, a chronic exposure would promote risk aversion. To test this hypothesis, we conducted a randomized double-blind, placebo-controlled, cross-over study in which hydrocortisone—the pharmaceutical form of cortisol—or placebo was administered to 36 healthy volunteers, 20 men and 16 women, aged 20–36 y, over an 8-d period. Subjects were randomly assigned to one of three treatment schedules: (i) active–washout–placebo, (ii) placebo–washout–active, or (iii) placebo–washout–placebo (this last schedule serving as a control to test for learning effects during the study). A series of computer tasks were used to measure participants’ risk preferences under control conditions (placebo-treated), under conditions of acutely elevated cortisol, and under chronically elevated cortisol. This protocol permitted us to assess whether risk preferences remained stable and, if they did not, whether the fluctuations in risk preference were physiologically driven, specifically by changes in the level of circulating cortisol.