The findings suggest a trading environment that is becoming less bold and more cautious with implications for the reaction function of financial markets that is very different than what we have become accustomed to.
When I studied academic finance in the early 1980s, the focus was on economic fundamentals and mathematical theories. “Behavioral” finance — which examined how the psychology of participants affected markets — was a niche field that many researchers disregarded entirely. But the influence of behavioral theories grew rapidly over the next couple of decades, and now it is a main pillar of the field.
Much of the early work on behavioral finance studied tendencies that were considered near universal in humans. That gave way to work that recognized differences among individuals, but these were often assumed to be set early in life and constant thereafter. Only in the last 10 years or so have behavioral finance theories that assume personalities are malleable in adults become mainstream. The pandemic is the biggest mass trauma that provides a natural experiment for these new ideas. How did the pandemic change the personalities of traders? What does that mean for financial markets?
Although this is a new area of academic study, it’s an ancient idea. It’s always been common to talk about traders being traumatized by some financial crisis, and to assume risk-taking declined as a result, removing liquidity from markets and depressing valuations. Most theories of financial bubbles and panics are psychological, as are many trade theses and strategies. But none of this is rigorous, and much of it is rooted in crude psychological stereotypes and superficial economic logic.
It might surprise you to learn that the New York Fed study found traders score higher on agreeableness — which includes trusting others and not finding fault — than a control group of students. Traders are supposed to be skeptical, even suspicious, constantly looking for faults and thinking in contrary ways. There are almost no disagreeable traders; they are all moderate or high on the characteristics. Students, however, can be low, moderate or high. High agreeableness doesn’t seem to be necessary for trading, but low agreeableness seems to be a disqualification.
What happened in the pandemic? Traders’ agreeableness crashed, from well above student levels to well below. Student agreeableness did not change significantly, so it was not a general effect on everyone. The effect was much larger on traders who had been personally impacted in negative ways — medically, economically or in a life situation. Oddly, among students there was a much smaller decline in agreeableness, but only among the students least affected by the pandemic.
The other big change was in a trait the authors call “locus of control,” or the extent to which people feel they control events and direct their lives. Here traders score much higher than students, as it appears that feeling in control is necessary for trading. On one hand, traders are supposed to have great respect for the market and randomness, which would seem to argue for low locus of control. But it seems instead that traders need a high locus of control to summon the psychic strength to make bold bets under uncertainty.
Locus of control also crashed for traders, although it remained well above student levels, which again did not change significantly. This change was the same for traders who reported a high or low impact of the pandemic on their lives.
This is just one study, and we don’t yet know whether this was a temporary or permanent change. But taken at face value, it suggests markets could be significantly more cautious as a result. Suspicious traders who don’t trust each other and don’t feel in control are not likely to take bold positions. If the younger generation was not affected, as seems to be the case in this study anyway, perhaps the market leaders of the next few years will be traders who were spared the specific traumas of trading during pandemic.
The other question is whether this type of research will yield significant market insights. Will we learn how markets shape traders’ personalities, and how those personalities then affect market behavior? Or will this remain an academic curiosity of little practical interest? Perhaps the next paper from this team will help answer the questions. More From Bloomberg Opinion:
• Want Trading Success? Learn Poker, Not Economics: Aaron Brown
• Banks Are Right to Clamp Down on Using ChatGPT: Paul J. Davies
• Is Michael Platt Finance’s Highest Earner?: Marc Rubinstein
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is author of “The Poker Face of Wall Street.” He may have a stake in the areas he writes about.
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