Would more women as traders make a difference?
This essay is adapted from The Hour Between Dog and Wolf, published this month by The Penguin Press.
If, as many maintain, women could have such a tonic influence on the markets, why are there so few women traders? Why are women not pushing their way onto the trading floors, and why are banks and hedge funds not waving them in? Women make up at most 5 percent of the traders in the financial world, and even that low number includes the results of diversity pushes at many of the large banks. The most common explanations ventured for these numbers are that women do not want to work in such a macho environment, or that they are too risk averse for the job.
There may well be a kernel of truth to these explanations, but I do not place much stock in them. To begin with, women may not like the atmosphere on a trading floor, but I am sure they like the money. There are few jobs that pay more than a trader in the financial world. Besides, women are already on the trading floor: they make up about 50 percent of the sales force, and the sales force sits right next to the trading desks. So women are already immersed in the macho environment and are dealing with the high jinks; they are just not trading. Also, I am not convinced women are as easily put off by a male environment as this explanation assumes.
There are plenty of worlds once dominated by men that have come to employ more women: law and medicine, for example, were once considered male preserves but now have a more even balance between men and women (although admittedly not at the top echelons of management). So I am not convinced by the macho environment argument.
What about the second-mentioned explanation, that men and women differ in their appetite for risk? There have been some studies conducted in behavioral finance that suggest that on computerized monetary choice tasks women are more risk averse than men. But here again, I am not entirely convinced, because other studies, of real investment behavior, show that women often outperform men over the long haul, and such outperformance is, according to formal finance theory, a sign of greater risk taking. In an important paper called “Boys Will Be Boys,” two economists at the University of California, Brad Barber and Terrance Odean, analyzed the brokerage records of 35,000 personal investors over the period 1991–1997 and found that single women outperformed single men by 1.44 percent. A similar result was announced in 2009 by Chicago-based Hedge Fund Research, which found that over the previous nine years hedge funds run by women had significantly outperformed those run by men.
Barber and Odean traced the women’s outperformance to the fact that they traded their accounts less. Men, on the other hand, tended to overtrade their accounts, a behavior the authors take as a sign of overconfidence, a conviction on the part of the men that they can beat the market. The trouble with overtrading is that every time you buy and sell a security you have to pay the bid-offer spread plus any commission, and these costs add up so quickly that they substantially diminish returns. Is the superior performance of women risk takers due to their lower transaction costs? Or is part of it due to higher risk taking? Or perhaps to better judgment? How can we reconcile the experimental findings that women are more risk averse with the data on their actual returns, which suggests either greater risk taking or better judgment? There is a clue that may help solve this mystery.
As mentioned, women make up about 5 percent of an average trading floor. But these numbers change dramatically when we leave the banks and visit their clients, the asset-management companies. Here we find a much higher percentage of women. The absolute numbers are not large, because asset managers employ far fewer risk takers than banks; but at some of the big asset-management companies in the United Kingdom women make up as much as 60 percent of the risk takers. This fact is, I believe, crucial to understanding the differences in risk taking between men and women. Asset management is risk taking, so it is not the case that women do not take risks; it is just a different style of risk taking from the high-frequency variety so prevalent at the banks. In asset management one can take time to analyze a security and then hold the resulting trade for days, weeks or years. So the difference between men’s and women’s risk taking may be not so much the level of risk aversion as it is the period of time over which they prefer to make their decisions.
Perhaps men have dominated the trading floors of banks because most of the trading done on them has traditionally been of the high-frequency variety. Men love this quick decision making, and the physical side of trading. But do trading floors today really need so many of these rapid-fire risk takers? Banks certainly do need them; but with the advent of “execution-only boxes,” we are now in a position to disaggregate the various traits required of a risk taker – a good call on the market, a healthy appetite for risk and quick reactions – and let computers provide the quick execution. Increasingly, all that is required of risk takers is their call on the market and their understanding of risk once they put on a trade; and there is no reason to believe men are better at this than women. Importantly, the financial world desperately needs more long-term, strategic thinking, and the data indicate that women excel at this. As banks, hedge funds and asset-management companies assess their current needs and more data emerges on the performance of women risk takers, the financial institutions will come, I believe, to hire more and more women.
Besides letting the market take its natural course, there is a policy that could hasten the hiring of women. That is to alter the period of time over which a risk taker’s performance is judged. The trouble in the financial world right now is that performance is measured over the short haul. Bonuses are declared yearly, and within this year there is a lot of pressure on traders to trade actively – floor managers do not like to see people sitting on their hands, even if it may be the right thing to do – and to show profits on a weekly basis. Perhaps this aggressive demand for short-term performance has prevented banks from discovering the high long-term returns of which women are capable. The solution to this problem is quite simply to judge women risk takers – all risk takers for that matter – over the long haul. Here again this goal could be served by calculating bonuses over the course of a full business cycle. Should we do that, we might find banks and funds not worrying too much about a slow period in a trader’s returns, but only about their returns over the cycle. The market would come to value the stability and high level of women’s long-term performance, and banks might naturally start to select more women traders. Affirmative action would not be needed.
There is, however, another perspective, a troubling one, from which to view this and any other proposed solution to the problem of market instability. It has been suggested to me that we should not try to calm the markets, because bubbles, while troublesome, are a small price to pay for channeling men’s testosterone into nonviolent activities. Andrew Sullivan has expressed a similar concern. Ruminating about the role of testosterone today, he worries that the real challenge facing us is not so much how to incorporate women more fully into society but how to stop men from seceding from it. A chilling thought.
Keynes entertained somewhat the same concern, and concluded that capitalism, rather than any of the other economic systems on offer during the 1930s, was the preferred antidote to our violent urges, quipping that it is better to terrorize your checkbook than your neighbor. So maybe it is better to have testosterone vented in the markets than elsewhere.
I do not think that follows. We tend to get extreme behavior of the sort that gives testosterone a bad name when we isolate young males. This phenomenon can be observed in the animal world, and most vividly among elephants. In the absence of elders, young male elephants go into musth prematurely, a condition in which their testosterone levels surge forty to fifty times above baseline, and then they run amok, killing other animals and trampling villages. In South Africa, park rangers have found a solution to the problem: they have brought in an elder male elephant, and his presence has calmed the rogues.
This example from the animal world is admittedly more extreme than anything we find in human society, but it does dramatically illustrate the point I am making. There may be times when we want young males to be cut loose, perhaps during times of war. But when it comes to allocating the capital of society, the financial sector’s allotted goal, we probably do not want volatile behavior. We want balanced judgment and stable asset prices, and we are more likely to get these if we have the whole village present – men and women, young and old.
I like this policy of altering the biology of the market by increasing the number of women and older men in it. It strikes me as eminently sensible, and my hunch is that it would work. To argue for it one need not claim that women and older men are better risk takers than young men, just different. Difference in the markets means greater stability. There is, however, one point about which I have much more than a hunch, about which I am as certain as certain can be – that a financial community with a more even balance between men and women, young and old, could not possibly do any worse than the system we have now. For the one we have now created the credit crisis of 2007–8 and its ongoing aftershocks, and there is quite simply no worse outcome for a financial system.
Lastly, this policy has some decent science behind it. It provides a good example of how biology can help us understand and regulate the financial markets, and it does so, moreover, in a manner that is not in the least bit threatening.
From THE HOUR BETWEEN DOG AND WOLF, by John Coates. Published by arrangement with The Penguin Press, a member of Penguin Group (USA), Inc. Copyright (c) John Coates, 2012.