Book Review: The Hour Between Dog and Wolf by John Coates

By Professor Jeffery Atik

What a fun book this is! The Hour Between Dog and Wolf by John Coates mixes pop finance with pop science, sketching some surprising links between them. I will trust Coates to get the science right (he provides citations). His investigation of financial markets is largely anecdotal and so speculative, but all the same it yields tantalizing suggestions.

Coates is a former derivatives trader -- which gives him authority to describe the subjective experiences of winning and losing at a trading desk. He (somehow) becomes hooked on neuroscience research; he describes himself sneaking away from his Wall Street desk to mix with scientists at Rockefeller University. The book seeks to bring these two worlds together. Coates immerses himself in the activation of hormones: testosterone, cortisol and the like. It is these chemical agents that produce the profound effects on the humors of financial traders, and hence overall market behavior.

Coates attacks the mind/body dichotomy: a financial market trader reacts more like an athlete than an analyst in responding to the stimula communication through his screen. Coates employs emerging understandings of mind/body feedbacks to track the play of traders. The traders can react before they 'see', rely on 'gut feelings' and engage in mano-a-mano combats from which they emerge winners or losers. These are quintessentially physical experiences. The markets themselves may then be understood as projections of this human biology.

Trading in financial markets, like war, is a young man's game. It draws on physical resources and reaction times, and a constitutional inability to fully appreciate surrounding dangers. But young soldiers require leaders with a different set of biological characteristics for larger scale success.

Coates develops a human biology account for market cycles. Biofeedback loops reinforce confidence in those traders experiencing winning streaks -- and most traders win in rising markets. The narcotic effect accompanying success then goads these traders to risk again and again, with ever greater stakes. The manic exuberance (a real physical effect produced by past successes) pushes speculators beyond 'rational' limits. Perspective is lost by nearly all at the top of a bubble.

So here in a nutshell is Coates' exuberance story. A (presumably male) investor enjoys a 'winner effect' from completing a successful trade. Testosterone released during the trade enhances risk appetite and confidence (which are in no small part ingredients for delusion!) When a winning trade closes, even more testosterone is produced, leading to still more confidence and greater appetite for risk. But this feedback eventually produces toxic consequences: aggressivity, social isolation and recklessness. The collective effect of many such hopped up winners is a financial bubble. The bubble is inevitably punctured by more sober (that is, less testosterone charged) contrarians.

A distinct, and powerful, feedback takes hold on the downward slide. Here losers lick their wounds, withdraw and seek to survive, prodded by the release of cortisol in their systems. The long-term effect of cortisol can lead to an irrational pessimism that mirrors the testosterone-produced exuberance experienced during the bubble. The cortisol contributes, Coates suggests, to the low part of the business cycle, where capital is hoarded and little ventured.

The science Coates presents is suggestive. It may or may not prove true that the 'black boxes' -- computerized trading systems -- will eventually outperform human traders. They likely already do so with respect to execution. And there may be a crossover point (computers now regularly win at chess and Jeopardy) where the black boxes prove themselves more able at identifying investment opportunities.

But perhaps not, as Coates argues that markets are fundamentally a human phenomenon, and as such behave in complex and perhaps thoroughly unpredictable ways. There may be no algorithm that can model a system so long as humans continue to play. We impose our biological irrationalities on markets -- and (as Keynes observed) a rational investor may not last long enough to profit. And if so, there is a role for human actors: our deeper -- biologically more primitive -- reactions may be better suited to predict and respond to the complex and emotionally charged vagaries of financial markets.

Further, our biology is essentially gendered. And so may be success in financial markets. Coates teases out a link between our gendered capacities in response to risks (of the stalking lion type) and success in longer term investing. Here women may have a biological advantage. At the least, argues Coates, financial management firms should happily diversify their personnel by including more women (and older men) whose response systems may be better suited to certain investment environments. An intriguing possibility, if one can overcome an instinctive revulsion to Coates' essentialism!

The Hour Between Dog and Wolf is shortlisted for the 2012 Financial Times and Goldman Sachs Business Book of the Year Award. The winner of the 2012 FT/GS Book Award will be announced November 1.

See my reviews of these other shortlisted books for the 2012 FT/GS Book Award:

Daron Acemoglu and James Robinson, Why Nations Fail - The Origins of Power, Prosperity, and Poverty

Steve Coll, Private Empire: Exxon-Mobil and American Power

Walter Isaacson, Steve Jobs

Michael J. Sandel, What Money Can't Buy - The Moral Limits of Markets

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