KARL MOORE – This is Karl Moore of the Desautels Faculty of Management at McGill University with Talking Management for The Globe and Mail. Today I am delighted to speak to John Coates who spent 12 years on Wall Street with Goldman Sachs and Deutsche Bank as a trader in the heart of the beast, then moved on and now is a senior researcher at Cambridge University Neuroscience and Finance.
So John you spent many years working on Wall Street, why did you turn to Neuroscience to better understand the trading that happens on Wall Street and the City in London?
JOHN COATES – I was running a trading desk for Deutsche Bank during the dot-com bubble and I noticed during that time that traders had started acting in a way that wasn't normal for their behaviour – they were euphoric, delusional, they were taking too much risk and the moreover had terrible risk-reward trade-offs. As I said, these traders weren't normally like that – normally they were a pretty prudent bunch. I wasn't caught up in the dot-com bubble but I certainly understood what they were going through because, on previous occasions when I had gone on a long-term winning streak and I was expecting this bonus, I got a chemical high that was as powerful as any urge I had ever felt and it is very difficult to control.
Similarly when you are losing money, you come to see the world in a different way. You begin to see conspiracies everywhere and that too feels like it is chemically driven. I became increasingly convinced that our body chemistry was playing a huge role in shifting our risk preferences across the business cycle and the more I looked into it the more I decided it was a hypothesis I wanted to test. So that is why I went back to Cambridge.
KARL MOORE – John, do you think when we look at the great recession we just went through that some of the work you have done really sheds light on how and why it occurred?
JOHN COATES – I think so because in the first stage of our research we were looking at the molecules underlying irrational exuberance and irrational pessimism. We all know they exist, as long ago as Keynes he was talking about animal spirits but the fact that we have got these phrases which we know make sense but we can't define them, I think there is a molecule of irrational exuberance and a molecule of irrational pessimism. Our original experiments were looking into the possibility that the irrational exuberance molecule was in fact testosterone that builds up in the bodies of the traders as they make money.
As testosterone levels rise in your body they start affecting the amount of risk you want to take and the way you assess risk. On the downside Cortisol levels, which is the most powerful stress hormone, also affects the way you think so you become dramatically and irrationally risk averse under chronically elevated levels of stress hormones. So we think on the upside, during the bubble, these testosterone levels were making the traders insensitive to risk-reward signals but also insensitive to price signals such as the rate of interest.
During the crash it didn't make any difference if you lowered interest rates as low as zero, they were so traumatized they were price insensitive. So if you have a financial community that, at the peak of the bubble, and the pit of the trough, is under the influence of these very highly elevated chemicals then they are basically price insensitive and I think that means that monetary policy stops working.