The Hour Between Dog and Wolf: How Risk Taking Transforms Us, Body and Mind

by John Coates

In short, nature and nurture, biology and management, both contribute to creating financial crises, and both need to be addressed if we are to mitigate them. I and my colleagues found evidence that management has more than enough clout to tame the beasts lurking within risk takers. For we found, in one of the studies previously mentioned, both high testosterone levels and high Sharpe Ratios (i.e., high profits relative to the risk taken) in the same traders. How can that be? If testosterone increases a trader’s appetite for risk, could it not just as easily lead to rogue trading? Probably. But on the floor where we carried out the study, the managers employed a draconian risk-management system—pulling the plug quickly on losing trades and telling traders to sit on their hands when not in the zone—combined with a profit-sharing scheme, and this had effectively harnessed the traders’ risk appetite. On this trading floor, nature and nurture combined to encourage prudent and profitable risk taking. In trading, as in sports, we concluded, biology needs the guiding hand of experience and well-structured incentives.