The Psychophysiology of Real-Time Financial Risk Processing

Abstract

Research support from the MIT Laboratory for Financial Engineering is gratefully acknowledged. We thank J.C. Mercier for helpful comments and discussion. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.

A Combination of Dopamine Genes Predicts Success by Professional Wall Street Traders

“…We found that they were good at integrating disparate pieces of information, eschewed trading in volatile markets, and did not view the world as threatening their survival. These findings align with previous evidence suggesting that more experienced traders may respond in a less emotional way than those with less experience [10]. Nevertheless, other studies of professional traders have found that they are susceptible to trading biases [70]–[72].…”

“…For example, Apicella et al (2008) found that levels of testosterone in saliva were associated with greater risk-taking in a laboratory investment game [9]. Field studies have also highlighted this relationship, demonstrating that when professional traders trade in volatile markets they have increased cardiovascular tone [10], and that morning testosterone levels predict professional traders' daily profits [11]. Both prenatal and circulating testosterone appear to influence the choice of a financial career and success in this field as measured by longevity [12], [13].…”

The Adaptive Markets Hypothesis

“…For example, contrary to the common belief that emotions have no place in rational financial decision-making processes, Lo and Repin [2002] present preliminary evidence that physiological variables associated with the autonomic nervous system are highly correlated with market events even for highly experienced professional securities traders. They argue that emotional responses are a significant factor in the real-time processing of financial risks, and that an important component of a professional trader's skills lies in his or her ability to channel emotion, consciously or unconsciously, in specific ways during certain market conditions.…”

“…Recent research in the cognitive neurosciences and economics suggests an important link between rationality in decision-making and emotion (Grossberg and Gutowski [1987]; Damasio [1994]; Elster [1998]; ; Loewenstein [2000]; Peters and Slovic [2000]; and Lo and Repin [2002]), implying that the two are not antithetical, but in fact complementary.…”

“…Where appropriate, I have modified passages to suit the current context without detailed citations and quotation marks so as to preserve continuity. Readers interested in the original sources may consult Lo [1997Lo [ , 2002, Lo and MacKinlay [1999], and Lo and Repin [2002]. 2 Only when these axioms are satisfied is arbitrage ruled out.…”