The Psychology of a Banking Crisis [Archive]

Daktoria

Jul 9th 2009, 11:52 AM

I read the article and while you know I'm not a fan of empiricism, it's really just hypothetical speculation that follows its own biased models.

For example:...In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability – presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions. If – as the research may suggest – men are less risk averse than women, then a work group composed primarily of men (or primarily of women) may be a particularly bad idea. A vast psychology literature documents the phenomenon that group deliberation tends to result in an average opinion that is more extreme than the average original position of group members. If a group is composed of overly cautious individuals, it will be even more cautious than its average member; if it is composed of individuals who are overly tolerant of risk, it will be even less risk averse than its average member (Buchanan and Huczynski 1997)....
In no way shape or form does her research suggest that men are less "risk averse" because sheer participation in risk is not what aversion is about. Risk aversion is the characteristic of optimizing expected returns by minimizing risk in terms of maximizing reward, a disappointing oversight considering Professor Sibert's credentials. Such disappointment lead me to follow up on her citation to see exactly what's going on here (http://www.pnas.org/content/105/16/6167.full):...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 (http://www.pnas.org/content/105/16/6167.full#ref-20)), appetite for risk (21 (http://www.pnas.org/content/105/16/6167.full#ref-21)), and fearlessness in the face of novelty (22 (http://www.pnas.org/content/105/16/6167.full#ref-22), 23 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-24)), because testosterone has also been found to lead to impulsivity and sensation seeking (25 (http://www.pnas.org/content/105/16/6167.full#ref-25)), to harmful risk taking (21 (http://www.pnas.org/content/105/16/6167.full#ref-21)), and, among users of anabolic steroids, to euphoria and mania (26 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-27), 28 (http://www.pnas.org/content/105/16/6167.full#ref-28)). It has also been found that testosterone and its metabolite, 3α-androstanediol, have rewarding and addictive properties, largely because they increase dopamine release in the shell of the nucleus accumbens (29 (http://www.pnas.org/content/105/16/6167.full#ref-29), 30 (http://www.pnas.org/content/105/16/6167.full#ref-30)), a brain region found to be stimulated in anticipation of irrational risk seeking (16 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-6), 7 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-6)); stimulate corticotrophin-releasing hormone (CRH) gene expression in the central nucleus of the amygdala and consequent feelings of anxiety (33 (http://www.pnas.org/content/105/16/6167.full#ref-33)); and produce a tendency to find threat and risk where none exist (34 (http://www.pnas.org/content/105/16/6167.full#ref-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 (http://www.pnas.org/content/105/16/6167.full#ref-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.** (http://www.pnas.org/content/105/16/6167.full#fn-8)....
To be fair regarding the emission of cortisol, it should be noted that because of secondary genes, men have higher cortisol levels than women and experience a higher degree of stress from Cortisol exposure. (http://www.sciencedaily.com/releases/2009/04/090405185031.htm)

Regardless, the Iowa Gambling Task is conveniently not mentioned to consider the opportunity of high variance yet positive expected returns. Such is important since small and tiny-cap stocks are the most volatile on the market despite how they also bear the strongest returns over the long run. (http://www.investopedia.com/printable.asp?a=/articles/stocks/07/size-value-premium.asp)

In other words, what I see in this article is a typical protectionist and fearmongering reaction against when times have gone bad which is opportunistically synthesized to glorify femininity for its cautious nurturing. Oddly though, Prof. Sibert did publish this article earlier which condemned Obama for encouraging protectionist policies (http://www.voxeu.org/index.php?q=node/953).

However, I will agree with her that businesses can be exclusively cliquey as much as any other hierarchy, and it probably serves failures right to have such a snide swipe dished out at them. Her emphasis on how incompetent bankers slide by through imitation, ergo, balances this glorification especially when considered in combination with the following reference in her protectionist condemnation article:...Sen. Barack Obama’s proposal is reactionary, populist, xenophobic and just plain silly. It is time for him to stop pandering and to show the world that hope and reason are not mutually exclusive. Instead of increased protectionism, the United States might increase its competitiveness by sensible investments in infrastructure and education. Much of the US infrastructure is old and inadequate following decades of bipartisan neglect; it serves as an obstacle to the ability of the United States to respond and adapt to change. It should not take the collapse of more than one major bridge in a large US city to spur increased investment. The quality of primary and secondary education in the US has fallen behind the level provided by most other industrial countries and is even threatened to be eclipsed by levels in quite a number of emerging market nations. The best American universities are still the best in the world. But, in America they are islands of excellence in a sea of mediocrity. China, India, Vietnam, Brazil, Thailand, Bangladesh and Indonesia are a reality. The United States must adapt and invest or face extinction.
Maybe she is or maybe she isn't a strong advocate of feminism, but considering the London School's reputation for balanced ideological discussion that falls somewhere between responsible libertarianism and individualist conservatism, I'd say that she's just moderating her portfolio for the sake of finding mental equilibrium between her professional and personal goals.

Solid article really all around, but it should not be interpreted as intent upon confiscating banker control over private property that they're hired to manage. Rather it should be acknowledged as a challenge against bank organizational culture that requires extensive internal reform.