Bubble and Bust

It's been a long time since the dot-com days of "irrational exuberance," but John Coates remembers them well: he lived them. As a Wall Street trader, he watched as his co-workers drove stock prices into the stratosphere and themselves into a frenzy. "They were acting like they were on a drug," he says.

Since then Coates has left Wall Street for the University of Cambridge and dedicated his time to figuring out what that drug was. In this week's Proceedings of the National Academy of Sciences he announces his results: it was testosterone. In a new study he reports that traders who start the workday with high testosterone levels make more money on that day than their low-testosterone colleagues do. A hot day on the market sends their levels of the natural steroid up even more, Coates says; under the influence of their own hormones, they start to take bigger risks in hopes of bigger rewards.

Classical economic theory assumes that people make financial decisions in a rational way. But Coates's finding is part of a growing body of work explaining why, in reality, they often don't: they're at the mercy of their biology. This school of thought helps illustrate how economic trends can get out of control, ballooning until they burst. It also suggests one reason why central banking is so tricky: policymakers don't often take hormones into account. "[Former Federal Reserve chairman] Alan Greenspan spent his whole career trying to control economic bubbles," says Coates. "I don't think he realized he was up against steroids."

Coates first started thinking about testosterone in traders when he came across the so-called "winner effect," a phenomenon that has been observed in the lab for more than a decade. In animals, success at a given task begets a boost in testosterone, which in turn begets a number of changes in the brain. An animal pumped up on testosterone makes decisions faster, tries harder to win and is willing to take risks that a more timid counterpart—perhaps one with a record of failure—won't go for.

"When he goes into the next round of competition, the testosterone gives him an advantage," says Coates, "and he may win again. It's a feedback loop." The winner effect has been examined in human male athletes, too, with the same results: a win releases more testosterone, which increases the player's chances of succeeding the next time around.

But winning can't go on forever, and, in fact, the kind of risky behavior needed for extreme success often leads instead to spectacular failure. That too owes something to hormones: too much testosterone can ultimately cloud a person's judgment. "Testosterone may help you make decisions faster," says Coates, "but it doesn't help you make better ones."