A sustained increase in the stress hormone cortisol leads to both a reduced tolerance for risk and an increased preference for perceived safer, but lower-return outcomes. This physiological response to stress may be a contributing cause to financial market instability, particularly during times of increased uncertainty.

A team of British and Australian researchers reached these conclusions after conducting a study on participants using a combination of cortisol dosing and computerized lottery games. The study was designed to measure risk preferences under placebo-treated, acutely elevated cortisol and chronically elevated cortisol conditions. Though the researchers had previously tested cortisol levels on London traders, this experiment allow them to test responses under controlled conditions.

The researchers focused on cortisol because long-term exposure to raised levels can impair behavioral flexibility and promote anxiety, depression and learned helplessness. The researchers said the effects associated with long-term exposure to elevated cortisol “could be expected to discourage risk taking.”

First, they looked at the average utility curve. The flatter the utility curve is, the less marginal benefit is derived from each incremental increase in the amount of benefit. In other words, a flatter utility curve implies that a person is less willing to incur greater risk in order to reap bigger potential rewards. Participants receiving acute doses of cortisol showed no significant difference in risk aversion than the control (placebo) group did. Participants with chronically elevated cortisol had a “large” increase in risk aversion, however.

Second, the researchers found that the group with higher cortisol levels placed a greater emphasis on small probabilities (a sign of more risk aversion).

Commenting on previous economic research treating risk tolerances as static, the study’s authors wrote, “We find, on the contrary, that financial risk preferences shift, and do so substantially. We further find that these shifts occur under the influence of a physiological mechanism, specifically the stress response...Our findings suggest that when people are stressed by chronic uncertainty or uncontrollable threat their endocrine systems discourage them from taking risk.”

Source: “Cortisol Shifts Financial Risk Preferences,” Narayanan Kandasamy, Ben Hardy, Lionel Page, Markus Schaffner, Johann Graggaber, Andrew S. Powlson, Paul C. Fletcher, Mark Gurnell and John Coates, Proceedings of the National Academy of Sciences of the United States of America, March 4, 2014.

Related

Financial Planning

Five Steps for Gaining Control of Your Investments and Avoiding Mistakes

Stock Strategies

15 Short-Cuts and Biases That Lead to Bad Investment Decisions