On April 24, 2013, CFA Society Toronto hosted its Annual Pension Conference, attracting a sold-out audience, thanks in large part to an impressive speaker line-up that included John Coates, a neuroscientist at the University of Cambridge and author of The Hour Between Dog and Wolf: Risk Taking, Gut Feelings, and the Biology of Boom and Bust. Coates’s book sets forth the workings of the mind and body in a modern situation—the financial crisis of 2007−2008. Much of Coates’s work is based on ground-breaking research that looks at the biology of risk taking, specifically, the effect of physiology on traders’ performance, gut feelings, fatigue, and stress. One study conducted on a trading floor looked at how winning leads to further wins, a phenomenon known as the winner effect. As Coates observed, “Stress induces physical reactions in many ways which alter risk and reward cognitive effects, and which, if repeated, alter the propensity for risk taking and, if chronic, may promote irrational risk/reward choices.”

Coates and others increasingly question the “Platonic” role of the brain and believe this has contributed to the broadly based assumptions in economics that we are rational and that investment markets are efficient. Coates noted that we see ourselves as emerging from our animal origins, with bigger brains, displaying all kinds of superior achievements. However, in reality, the greatest human achievements are in motion, and the role of the brain is just to keep up with the evolution of the body.

Coates stressed that our reaction to stress from modern financial markets is no different from that of primitive stress situations—savannahs, jungles, and forests—where brain and body are attuned to facing sudden, potentially fatal, threats from predators. Today’s stressful situations (whether winning or losing) are different in that they can occur often and can last for long periods, but the mind and body do not clearly distinguish between physical and psychological stress, but they react in the same ways. Despite our vastly superior evolution, we are still subject to what our body prepares us to do through often preconscious and uncontrollable responses.

Fight or Flight

Hormones are powerful chemical messengers originating in different glands located all over the body and sent through the bloodstream to almost every part of the body, depending on their purpose. Testosterone and cortisol are part of a class of steroid hormones. When the brain recognizes stressful situations, it signals the initiation of the steroid production process.

Testosterone prepares the mind and body for “fight or flight,” increasing blood capacity and lean muscle mass, plus enhancing confidence and appetite for risk. Repeated doses increase these effects and lead to the “challenge effect” (in humans) or “winner effect” (in animals). These are well documented and lead to greater success initially, but only up to a point, after which overconfidence and reckless behaviour can result in failure and loss.

Cortisol is a body-wide response to injury or threat. It works much more slowly and lasts much longer than immediate chemical responses, such as adrenaline. While in normal doses it increases vigilance, motor performance, and attention, like testosterone, after reaching some acute level, it has the opposite effects, causing anxiety, selective recall of disturbing memories, and an excessive fear of danger—i.e., risk aversion. Eventually, chronic cortisol exposure breaks down tissue in the body, which seriously affects the cardiovascular, digestive, and immune systems.

Coates discussed these effects in our modern workplace, including the differences in how they effect men and women and their performance under stress. He concluded with his main point: the body, more than the brain, registers an earlier and stronger recognition and response to risk. Understanding this helps greatly in coping with our day-to-day stress in the financial workplace. He added a note for future research on “shifting risk preferences,” an emerging field that is important in understanding dynamic repeated stress affects.