Even pro financial traders buy in bubbles writes…

Even pro financial traders buy in bubbles, writes @timkiladze citing neuroscientist John M Coates. Builds on behavioural science research by Charles Holt, Vernon Smith, Daniel Kahneman, Scott Huettel.

John Coates, a Canadian-born research fellow in neuroscience and finance at the University of Cambridge and a former trader at Goldman Sachs and Deutsche Bank, has run experiments on trading floors in the City of London.

“Once you start making above-average profits, as most people do during a bull market, you start getting this high,” he says. “I think it’s enough to pretty much squash memory” of previous bubbles.

His new book, The Hour Between Dog and Wolf, details these findings and ties them back to what the behavioural economists started studying years ago.

Prof. Coates admits that even he, someone equipped with a PhD in economics from Cambridge, has fallen victim to the testosterone highs. “I don’t think I ever would have hit on this if I hadn’t experienced it myself,” he says. “We have an unstable biology, and it’s very powerful.”

Yet there are people – even whole firms – who appear to effectively game these bubbles. At a recent luncheon, Prof. Holt, the University of Virginia behavioural economist, had a conversation with a successful hedge- fund manager who confided that he did not trade on companies’ long-term fundamentals.

Instead, he looked at the previous seven days of trading and read newspaper headlines and television talking points, going by the theory that economist Burton Malkiel espoused – that “a blindfolded chimp throwing darts at the Wall Street Journal” had a 50-per-cent chance of beating the market, because humans are so subject to their irrational psychology.  […]

Human biases are “so ingrained that just knowledge isn’t enough to overcome them,” Dr. Huettel says.

“From an evolutionary point of view,” says Caltech’s Prof. Camerer, controlling urges “basically isn’t something that any other species needed the capacity to do.” Add in the financial incentives on Bay Street and Wall Street, and we practically jump at bubbles.

For traders, “there’s no downside to rolling the dice,” Prof. Coates says. “Bubbles occur once every five years, but in the meantime you’ve pocketed four bonuses, and you don’t give them back.”

Why do we keep falling for economic bubbles – and will we ever learn? | Tim Kiladze | May 26, 2012 | The Globe and Mail at http://www.theglobeandmail.com/report-on-business/why-do-we-keep-falling-for-economic-bubbles-and-will-we-ever-learn/article2444187/singlepage/#articlecontent.

Why do we keep falling for economic bubbles – and will we ever learn? - The Globe and Mail

John Coates is at Cambridge Neuroscience at http://www.neuroscience.cam.ac.uk/directory/profile.php?jmc98