The Psychology Behind Risk Taking

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• The Psychology Behind Risk Taking
• Behaviours in Financial Traders.
• Why did they gamble away all our money?
• Edna Agbarha
• BSc., MSc., MBA., C.Occ.Psychol.
• Zeal Consulting
• Association of Business Psychologists
• Annual Conference, May 2009

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Todays Agenda

• Background context
• Define risk
• Research questions
• Literature review
• Research methodology
• Selected key findings case study
• Cognitive and emotions drivers associated with
  taking risky decision
• Discuss practical HR implications

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Background Historical Context

• Thatcherism Reagan
• Tough times rising inflation, unemployment,
  interest rates, bureaucratic govt.
• Tough measures Privatisation, state budget cuts,
  moves against labour, deregulated financial
  markets
• Boom-Bust of 80s 90s
• Banking finance contribution to GDP
• Start of slippery slope

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Background Research Context

• Increased higher-risk lending
• Subprime mortgage crisis in USA 2006/7
• Banks hit
• Lack of capital and liquidity
• Global repercussions and economic uncertainty
• Global credit crunch
• Panicked investors and savers
• Job losses and redundancies!

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Defining Risk
Risk taking a decision with some uncertainty
associated with the decision variables a
probability that returns may either increase or
decrease and an expectation of how much the
potential variability in returns is likely change
(Dembo Freeman,1998).

• Why do people take risks?
• Can risk be managed? If so, how?
• What is a market?
• Can a market ever be free of risk?
• What is the process by which risky decisions are
  taken?
• Can the quality of risk taking be improved? If
  so, how?
• Risk appetite whats yours? Seeking, neutral or
  averse?

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Research Questions

• Which cognitive biases have the biggest impact on
  risk taking and trading performance?
• How do emotions affect risk taking?
• What personality traits help or hinder trading
  performance?
• What learning strategies do traders adopt in
  order to cope with financial losses?

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Summary of Literature Review

• Rational beings
• Emerging field of Behavioural Finance
• Psychological Biases tendencies to
  behave/think/feel a particular way
• Systematic cognitive processes when trading
• Heuristics cognitive shortcuts employed to
  enable information processing
• Cognitive biases
• Bounded Rationality
• Hindsight Bias
• Emotional biases
• Mood Maintenance

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Expected Utility Theory

• Bernoulli (1954) decision makers choosing between
  risky or
• uncertain options will compare the expected
  utility.
• There is a basic assumption that decision makers
  are rational
• and therefore will choose the option with the
  highest utility.
• (Comparing the expected utility values by adding
  the utility
• values multiplied by their respective
  probabilities).
• I can calculate the motions of heavenly bodies,
• but not the madness of people."
• Sir Isaac Newton (1721).

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Testing Expected Utility Theory

• Gambling activity
• Groups of 4/5
• Two gambling opportunities A B
• Which gamble should you take?
• 5 minutes

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Prospect Theory
Value
A descriptive model of decision making under risk
Framing Effects
Losses
Gains
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Risk Neutrality
Source Psychologists Kahneman Tversky (1979)
Value -
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Methodology Composition of Participants
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Methodology Data Collection

• Critical Incident an event in which there is a
  large gap between expectation and experience,
  which produces a significant emotional change.
  (Flanagan, 1954).
• 19 in-depth semi-structured interviews using
  critical incident technique
• Context, reasons for taking risk, risk
  management, cognitive emotional drivers,
  learning mistakes, coping strategies.
• Thematic Analysis
• QSR NVivo software
• Personality questionnaires

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Findings Six Emerging Themes

• Distinct trader personality profiles
• Emotional effect of monetary gains or losses
• Limited support for different cognitive biases
• Type of learning depends on the outcome (whether
  ve or ve)
• Controlling emotions is perceived to lead to
  positive outcome
• Use of intuitive judgement rather than financial
  science

Findings Four Personality Types

• Type 1 Bold Impulsive (n 3)
• Type 2 Driven Optimist (n 7)
• Type 3 Driven Reviewer (n4)
• Type 4 Measured Calculator (n3)

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Findings Classification of Emotions
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Findings Emotions and Money
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Some Conclusions

• Cognitive
• No evidence of Hindsight Bias
• Emotional
• Little evidence to support Mood Maintenance
• Frequent mistakes made by traders are the
  tendency to be overcautious or overly impulsive
• Internal regulation of emotions

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Whos to Blame?

• The scale of failure ranges from financial
  institutions failing to national
• economic meltdown
• Mix of trader backgrounds lots of power
  authority devolved
• Pantheon of highly intelligent risk takers who
  have surprisingly become unstuck
• Demise and near collapse of Long Term Capital
  Management (LTCM) a highly-respected
  prestigious hedge fund founded 94
• Hubris omnipotence and omniscience, gods of the
  universe
• Do not think of yourself more highly than you
  ought, but rather think of yourself with sober
  judgement. (Romans 123)
• Baring Brothers and Co bank - Nick Leeson
• Société Générale - Jerome Kerviel
• Northern Rock, RBS
• Iceland and Belgium

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Contact Details

• Edna Agbarha - Zeal Consulting
• Mobile [phone]
• edna_agbarha_at_hotmail.com
• Feel free to leave your details for slides,
  flips, handouts, further information and more
  details.
• Website www.zealconsulting.biz (coming soon!)

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