Financial markets may be more vulnerable to traders’ stress levels than previously thought, according to a scientific study which found that high levels of the stress hormone cortisol can induce risk aversion.

The findings, which turns on its head the assumption that traders appetite for risk-taking remains constant throughout market up and downs, suggests stress could in fact make them more cautious, exacerbating financial crises just at a time when risk-taking is needed to support crashing markets.

In a study of City of London traders and of the effect of cortisol on behaviour, researchers led by Dr John Coates – a former Goldman Sachs and Deutsche Bank derivatives trader turned neuroscientist – said this tendency towards caution could be an “under-appreciated” cause of market instability.

Coates also said the finding could alter our understanding of risk – since up until now, financial and economic models have largely rested on the assumption that traders’ personal risk preferences are consistent throughout the market cycle.

“Any trader knows that their body is taken on a roller coaster ride by the markets. What we haven’t known until this study was that these physiological changes – the sub-clinical levels of stress of which we are only dimly aware – are actually altering our ability to take risks,” said Coates, now a researcher in neuroscience and finance at Cambridge University.

“It’s frightening to realise that no one in the financial world – not the traders, not the risk managers, not the central bankers – knows that these subterranean shifts in risk appetite are taking place.”

Coates team based this study on the findings of previous research conducted with traders in the City of London, which found that cortisol levels rose by 68 percent over a two week period when market volatility increased.

Combining that field work with a laboratory study, they gave hydrocortisone, the pharmaceutical form of cortisol, to 36 male and female volunteers aged between 20 and 36 over eight days to test the effects of raised cortisol on financial risk-taking.

The volunteers’ cortisol levels were upped by 69 percent – almost exactly the levels seen in the traders. They were then asked to undertake a series of financial risk-taking tasks with real monetary pay-offs, designed to measure their risk appetite and the probability judgment driving their risk taking.

In a report of their findings in the Proceedings of the National Academy of Sciences (PNAS) journal, Coates’ team found that initial spikes in cortisol had little effect on behaviour.

But chronically high and sustained levels, as seen in traders in the field study, led to a dramatic drop in willingness to take risks, with the “risk premium” – the amount of extra risk someone will tolerate for the possibility of higher return – falling by 44 percent.

“Many influential models in economics, finance and neurobiology assume risk preferences are a stable trait, but we find they are not,” the researchers wrote.

The team noted that during the credit crisis of 2007 to 2009, volatility in U.S. equities spiked from 12 percent to more than 70 percent.

They argued that such historically high levels of uncertainty could have caused cortisol levels to rise far higher and for longer than this study analysed, and therefore that chronic stress may have reduced risk taking just when the economy needed it most – when markets were crashing and needed traders and investors to buy risky assets.

“Traders, risk managers, and central banks cannot hope to manage risk if they do not understand that the drivers of risk taking lurk deep in our bodies,” Coates said. “Risk managers who fail to understand this will have as little success.”