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Cortisol is known to have powerful cognitive and emotional effects. Amongst these effects are heightened memory for adverse events, and alteration in mood. Together, these effects would tend to decrease a trader’s risk taking.

Exaggerated downward movement 

A situation of persistently elevated cortisol might occur if financial market volatility were to rise for an extended period, something that normally happens when the economy receives an unwelcome shock or enters a depression.

Cortisol is likely, therefore, to rise in a market crash and, by increasing risk aversion, to exaggerate the market’s downward movement.

Testosterone, however, is likely to rise in a bubble and, by increasing risk taking, to exaggerate the market’s upward movement.

These steroid feedback loops may help explain why people caught up in bubbles and crashes often find it difficult to make rational choices.

Learned helplessnness 

Dr. John Coates, lead author, said, "Rising levels of testosterone and cortisol prepare traders for taking risk. If testosterone reaches physiological limits, however, as it might during a market bubble, it can turn risk-taking into a form of addiction, while extreme cortisol during a crash can make traders shun risk altogether."

Coates, himself a former trader, added that in the present credit crisis traders may feel the noxious effects of chronic cortisol exposure and end up in a psychological state known as 'learned helplessness'.

“If this happens central banks may lower interest rates only to find that traders still refuse to buy risky assets. At times like these economics has to consider the physiology of investors, not just their rationality,” he concluded.

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Related links 

• Cambridge Centre for Brain Repair