Recent literature emphasizes the role that testosterone, as well as markers indicating early exposure to T and its organizing effect on the brain (such as the ratio of second to fourth finger, ), have on performance in financial markets. These results may suggest that the main effect of T, either circulating or in fetal exposure, on economic behavior occurs through the increased willingness to take risks. However, these findings indicate that traders with a low digit ratio are not only more profitable, but more able to survive in the long run, thus the effect might consist of more than just lower risk aversion. In addition, recent literature suggests a positive correlation between abstract reasoning ability and higher willingness to take risks. To test the two hypotheses of testosterone on performance in financial activities (effect on risk attitude versus a complex effect involving risk attitude and reasoning ability), we gather data on the three variables in a sample of 188 ethnically homogeneous college students (Caucasians). We measure a digit ratio, abstract reasoning ability with the Raven Progressive Matrices task, and risk attitude with choice among lotteries. Low digit ratio in men is associated with higher risk taking and higher scores in abstract reasoning ability when a combined measure of risk aversion over different tasks is used. This explains both the higher performance and higher survival rate observed in traders, as well as the observed correlation between abstract reasoning ability and risk taking. We also analyze how much of the total effect of digit ratio on risk attitude is direct, and how much is mediated. Mediation analysis shows that a substantial part of the effect of T on attitude to risk is mediated by abstract reasoning ability.

Introduction

To understand human nature and socioeconomic behavior we need to understand not only the basic traits of individual personality separately, but also how they are related and interact with each other, and the biological basis of these traits and their connection. Two important traits that have been recently explored are reasoning ability and the willingness to take risks. In this paper we explore the connection between these two factors and the possible biological factors affecting them.

Among the biological factors influencing willingness to take risks, several studies have found both pre-natal and circulating testosterone (T) levels to be an important factor affecting behavior under uncertainty. The implications of these effects on real life, in addition to experimental behavior, may be large and important. For example, in [1] the level of daily profits in a sample of traders in the City of London was found to be positively correlated with the deviation from the median level of salivary T of each trader. Similarly [2], found the level of average profitability over a longer period to be negatively correlated with the ratio of the second to fourth finger ( ratio). This ratio (see [3] for an introduction) is considered to be a marker of early (fetal) exposure to T.

A simple explanation of the link between T and performance in financial activities as found in [1] and [2] reduces higher profitability to the willingness to take risks. This account would suggest that on days when traders have a higher level of endogenous T relative to their own median level or a higher level of prenatal T exposure, traders' behavior is simply closer to risk neutrality, and they therefore choose, relative to other traders, portfolios with higher returns and higher variance. In the long run higher returns of the chosen portfolio ensure higher mean profits that we observe. This explanation interprets the correlation as a causal link from the level of T to attitude to risk. The explanation is appealing, but is unlikely to be complete. In fact, a higher variance in portfolio returns implies a higher variance in cumulated profits. If a lower bound on losses is imposed (for example, by the limit to total losses by the firm in the sample of traders in [2]), then a trader with higher propensity for risk should also be more likely to cease trading and exit the job. Thus, that account also predicts that traders who are more willing to take risks and earn higher returns should also experience a larger exit rate and shorter seniority on average. This is also what we should expect from theoretical investigations ([4], [5]) on the relationship between attitude to risk and survival in the market: everything else being equal (in particular, given the same inter-temporal preferences and beliefs, or information), risk-neutral traders are not those most likely to survive market selection. Instead, in [2] traders with a low digit ratio were also more likely to have higher seniority, indicating a higher probability of remaining on the job.

Willingness to take risks may be generally related to sensation seeking. Biological characteristics associated with this trait have been studied extensively, finding that T is one of the factors that has been associated with it ([6], [7]). In this paper we use the ratio as a measure in an experimental study. The specific link between the ratio and attitude to risk has been studied recently to test the hypothesis that lower digit ratios are associated with a higher willingness to take risks. The results are mixed (see [8] for a survey). An early study on 147 students found a positive correlation between digit ratio and risk aversion in an investment game (see [8]). The same result did not replicate in a sample of 125 ethnically heterogeneous subjects reported in the same study. Other studies that failed to replicate significance of the association are [9], [7], [10] and [11].

The sample in [9] was composed of 98 ethically heterogeneous subjects. [7] used a sample of 550 MBA students at the University of Chicago (381 male). The subjects were homogeneous in terms of age, cultural and educational background, and socioeconomic status. However, no precise information on ethnic background is provided in the text. They find that higher levels of circulating T is associated with lower risk aversion among women, but not among men. When they consider low concentrations of salivary T, the gender difference in risk aversion disappears; a result that suggests nonlinear effects of T on risk aversion regardless of gender. A similar relationship was also found between risk aversion and markers of prenatal T exposure. For example, the digit ratio was negatively correlated with the probability of pursing a career in finance. In a sample of 400 ethnically heterogeneous subjects [10], measure attitude to risk in bidding behavior. The task is a repeated two-bidder first-price sealed-bid auction with symmetric independent private values [11]. does not find an association between digit ratio and risk attitude (in a Holt and Laury task) in a sample of more than 200 subjects. A significant association between digit ratio and attitude to risk was found in [12] in a homogenous sample of 151 undergraduate students of both genders. Attitude to risk was measured by lottery choice in an Eckel–Grossman “50–50” [13] task [14]. find that the ratio predicts the amount of risk taken by 53 traders on a trading floor in the City of London but not their Sharpe ratios.

A possible explanation for the ability of low digit ratio traders to survive is that the biological factor represented by the marker affects, in addition to risk taking, the general ability of individuals to process information and perform cognitive tasks. Evidence that the ratio affects some cognitive skills is surveyed in ([3], [15]), particularly in the areas of musical ability ([16]), spatial perception and cognition ([17], [18], [19], [20], [21]), verbal and numerical intelligence ([22]), memory recall ([23]), and the SNARC effect (Spatial Numerical Association of Response Codes) ([24]). Females affected by Congenital Adrenal Hyperplasia, a condition that exposes fetuses to high levels of androgens in the womb, scored higher on tests of spatial ability (i.e., Hidden Patterns, Card Rotations, and Mental Rotations: [25]). Recently, several studies ([26], [27], [28]), [29], [30]) have presented evidence that traits affecting economic behavior like risk aversion and impatience in choices among payments over time are correlated with several measures of cognitive skills. Specifically, for risk aversion, a finding which has been replicated ([27], [30]) is that a higher reasoning ability is broadly associated with higher willingness to take risks, particularly in the gain domain. Reasoning ability in the population may peak around risk neutrality ([27]). Recently, Manning and Fink [31] found a significant correlation of the ratio with personality profiles in a sample of individuals in 23 countries. A result which is closely related to our study is their finding that a low per-country 2D∶4D ratio is associated with low risk aversion for the same country. They also find that a low 2D∶4D ratio per country is also associated with higher Gross Domestic Product. Possible explanations for this link may include the already noted higher risk tolerance associated with a low digit ratio, as well as a higher IQ in the population. Both explanations are consistent with the results we report below.

The hypothesis tested in the study we report is natural: a common biological factor (related to early exposure to T and reflected in the digit ratio) simultaneously influences reasoning ability and attitude to risk. We test this hypothesis in a simple experimental design where we gathered information on risk attitude, digit ratio, and reasoning ability in a sample of males and females. This analysis will allow us to test the relative size of the effects in addition to the simple existence of a correlation. We can also test the extent to which the effect of this biological factor directly influences risk attitude, and how much this effect works its way through reasoning ability. To determine this we will use simple mediation analysis, taking the digit ratio as the independent variable, the risk attitude as the dependent variable, and reasoning ability as the mediating variable.