The Market Economy

Financial traders' success may depend more on their biological traits than on their ability to make rational choices, researchers at the University of Cambridge have discovered.

We were surprised to find that exposure to hormones in the womb had such a strong influence on future trading performance.

John Coates

The research, published today in the journal Proceedings of the National Academy of Sciences (PNAS), found that individuals who were exposed to high levels of prenatal testosterone tended to be more profitable traders.

Testosterone, a steroid hormone, surges between the 9th and 18th week of gestation, exerting powerful organizing effects on the developing body and brain. According to both animal and human studies, these effects may include increased confidence, risk-preferences and search persistence, as well as heightened vigilance and quickened reaction times.

The amount of testosterone one was exposed to in the womb can be measured because it leaves traces throughout the adult body. Measures of prenatal androgens are increasingly used by paediatricians to gauge whether a newborn has been exposed to abnormal levels of steroid. The most common measure for behavioural studies is the ratio of the index to ring finger (2D:4D) on the right hand, a relatively longer ring finger - lower 2D:4D - indicating higher prenatal testosterone levels. Males typically have ratios below 1, women above 1.

As digit ratios have been found to predict performance in competitive sports such as tennis, football, and skiing, the scientists hypothesised that 2D:4D may also influence the risk preferences and physical speed required for what is variously called noise or high-frequency. Traders engaged in high frequency trading look for fleeting price anomalies and hold their trades for minutes, sometimes mere seconds.

For the experiment, the researchers recruited 49 male traders from a trading floor in the City of London. This floor employs approximately 200 traders who specialise in high-frequency trading, all but three male. The more successful traders are paid over £4 million a year.

Great care was taken to ensure that the traders all practiced the same style of trading and that their profits (P&L) reflected only their risk-taking skill. All traders therefore had equal access to capital and information. Moreover none of them benefited from an underlying client business, as do flow traders at the investment banks, flow traders' P&L partly reflecting the size of the bank's sales force rather than pure risk-taking.

The Cambridge scientists - John Coates, Mark Gurnell, and Aldo Rustichini - found that individuals who scored high on the measure of prenatal testosterone tended to be more profitable traders; and they tended to remain traders longer than others. The size of the effects was surprising, with traders exposed to high levels of prenatal testosterone making on average six time the profits of traders exposed to low levels.

The study draws attention to the fact, often overlooked by economists, that traders require more than a calculating mind; they must also possess confidence, an appetite for risk, and the ability to process information quickly. Furthermore, high frequency traders require additional skills because their rapid style of trading is a demanding physical activity: they engage in extended periods of vigilance and visual scanning, and they must react quickly in order to place a trade before others arbitrage it away.

John Coates, lead author and himself a former trader, said: "We were surprised to find that exposure to hormones in the womb had such a strong influence on future trading performance. But we should not conclude from this that to succeed in all types of trading you need high levels of prenatal testosterone. There are different market segments and trading styles and each of these may select for different traits. Indeed the traits that benefit high-frequency traders may prove a hindrance in positions involving more long-term investments.

"Banks, like an Olympic team, need both sprinters and marathon runners. Problems arise when the short-term trading mentality spreads into banking activities where long term value needs to be assessed. When it comes to long-run investments we may well find that successful individuals have higher, more feminine digit ratios"

The Efficient Market Hypothesis in economics has long claimed that markets select for rational expectations. The current study breaks new ground in showing how physical attributes can play a more important role in a trader's success. As such the study belongs to a growing body of research showing how the body plays a role in economic risk-taking.

Coates, of Cambridge University's Judge Business School, continued: "Does our research herald a dystopian future in which hiring on Wall Street is decided by the presence of a bio-marker? It is unlikely. Population statistics such as ours give average effects over a population but can be tricky when applied to individuals.

"Consider, for example, the analogous case of height in tennis: height gives an advantage in serve speed and reach at net, but selecting players on the basis of height would lead a coach to miss a Jimmy Connors, who is a slight 5'9" yet has won eight Grand Slam titles. A similar story could be told about 2D:4D and trading skill, for there are many other attributes that contribute to success, like education and ability to collaborate. Equally important is the quality of training and risk management that - in principle - guide the traders."

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