Market's Missing Fear Factor

People with higher initial risk perceptions are more likely to get vaccinated against Lyme disease. There's a lesson in that.

It stands to reason that people who have watched Hostel, a 2005 horror film that depicts a young man inhumanly tortured in a dark basement, are more likely to avoid budget lodgings. In a similar vein, research has found that those who have lived through the global financial crisis are more likely to shy away from taking on too much risk. Which is why banks, and their shareholders, should be worried as many of the more experienced traders quit the market.

Over the past eight years, financial institutions have reduced their personnel ranks often by cutting the oldest, and better paid, traders first. Bloomberg News's Alastair Marsh reported on Monday that about 70 percent of credit traders who lost their jobs at the biggest investment banks in London last year had worked in the financial industry for more than a decade. According to a recent survey by salary-tracking website, 63 percent of some 2,223 respondents had less than nine years' experience under their belt. That means most of them weren't managing any risk whatsoever when the credit crisis was wiping billions from bourses.

Flying Blind

Almost two thirds of trading jobs are now filled with people who have little crisis experience


Unlike wet-behind-the-ears Wall St. wannabes, experienced traders know how to mitigate losses. They know how to protect, or even add to, gains in volatile times, and they have Rolodexes that allow them to find buyers when there are none.

End of Days

Corporate bond returns are showing signs of having peaked, and that's an environment which favors hedging

There is another issue, though. 

Plenty of studies, especially in the medical field, relate risk perception and risk taking. In 2004, for instance, psychology researchers at Rutgers University in New Jersey found that people with higher initial risk perceptions were much more likely to get vaccinated against Lyme disease. That can be seen in markets as fearful bond traders buy credit-default swaps or hedge their positions.

Add to that the higher-than-usual predisposition of young people to take risk -- there's a reason why drivers over 30 pay lower car-insurance premiums -- and the problem comes into sharper focus.

Trend Reversal

World equity markets have recouped losses quickly, but what goes up must come down

Source: Bloomberg

Living through a crisis teaches people fear, and that may be the difference between doubling down or taking your cards off the table when markets turn bearish. Traders with little or no fear may be compelled to wade in deeper, leading to further pain. That's precisely what Jerome Kerviel, the Societe Generale trader who in 2008 caused the bank to lose 4.9 billion euros ($5.5 billion), did. 

Kerviel was exploiting a gap in oversight that allowed him to make directional bets, in a similar way Barings' Nick Leeson caused the lender to be declared insolvent in 1995. Hopefully, such loopholes have been closed. Yet even if a trader can't bet the bank on the direction of a market, the sort of behavior that Kerviel and Leeson, both of whom had less than five years' trading experience, exhibited when facing losses could easily happen again.

That's not to say older heads wouldn't have made the same mistakes in their time. But if they had, it's unlikely they'd do it again. As actor Will Rogers once said, good judgment comes comes from experience, and a lot of that comes from bad judgment.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Christopher Langner in Singapore at

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    Katrina Nicholas at

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