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Anxiety attacks

Our attitudes to risk are shaped by much more than merely objective circumstances

It’s widely agreed that stock markets have fallen because of increased tensions between the US and North Korea. The question is why?

It’s certainly the case that small changes in the probability of catastrophe can generate big moves in share prices. An increase in the chance of nuclear war from negligible to slight is enough to hurt shares.

This theory, however, runs into a problem. If the threat of nuclear war has increased, however slightly, we should have seen a fall in bond prices. This isn’t simply because there’s no point holding long duration assets if your life expectancy is short. It’s also because the cost of repairing the damage of a nuclear strike would add to global government debt. And yet government bond prices even in South Korea have barely changed, while yields in Japan, the US and UK have fallen.

This is inconsistent with the idea that markets have suffered because of an increased threat of nuclear war. It is, however, perfectly consistent with an increase in general economic anxiety: this usually sees shares fall and bond prices rise.

This suggests another mechanism whereby US-North Korean tensions have hurt shares. It’s that anxiety about one thing spills over into anxieties about others. What we’ve seen, then, is a form of contagion; worries about North Korea have led to worries about the general economic climate.

We know such spill-overs happen. Here are three examples:

 - The seasonal pattern in shares: prices tend to be depressed in the autumn, but over-inflated in the spring. This might well reflect changes in our mood. We become anxious as the nights draw in – Halloween demarks a scary time – and optimistic in the spring. These moods infect our assessment of the stock market.

 - Weather. Will Goetzmann and Tyler Shumway and colleagues show that markets are more likely to rise on sunny days than cloudy ones. The weather tells us nothing about future profits, but it affects our mood.

 - Football results. Alex Edmans and colleagues show that a country’s stock market tends to fall after it loses a World Cup match. Disappointment about football spills over into pessimism about equities.

What’s more, events early in our life can affect our attitudes to equities years later. Ulirike Malmendier and Stefan Nagel show that people who grow up in a recession hold fewer equities later in life than those who grew up in better times. Henrik Cronqvist and colleagues show that people who grew up in poor homes or who entered the labour market in a downturn are less likely to hold growth stocks years later even if they are just as well-off as those who enjoyed better starts in life. And Alessandro Bucciol and Luca Zarri show that parents who suffered the death of a child become more cautious investors.

These scarring effects might well be shaping the economy today. It’s likely that memories of the 2008-09 recession are depressing investment plans and wage demands now. Of course, there might well be rational reasons for these to be weak, but what happened nine years ago is not one of them.

All this tells us that worries at one stage of our life – will my parents be able to pay the rent? Will I get a job? – shape our attitude to the economy years later, even though they tell us nothing about economic prospects. In this way, we can be nervous and jumpy even if logic and facts don’t justify us being so. As Jason Isbell sings: “Anxiety, how do you always get the best of me? I’m out here living in a fantasy and I can’t enjoy a goddam thing.”

The converse is also true: good times cause us to ignore risks. Hyman Minsky argued that stability is inherently destabilising because it leads to overconfidence and excessive risk-taking and hence to a financial crisis.

The tiny minority of investors who can rein in their emotions can’t eliminate these mispricings, because there’s a risk they will get worse: nervous markets can become more nervous, and complacent ones more complacent. 

Anxieties are not something we can put in a box and keep in their proper place. Instead, they slop around and discolour other things. This makes me suspect that worries about North Korea are not confined to North Korea, but have instead altered our view of the world economy.

One reason for this is that they have shifted our attention. They have distracted us from a reason to be cheerful – the world economy is enjoying non-inflationary growth – to a reason for concern: President Trump’s shortcomings. The half-full glass has become a half-empty one.

All this is not merely a story about a few days of stock market gyrations which – we all hope – will soon be resolved. It’s a wider one. Our attitudes to risk are not based merely upon an objective assessment of the circumstances. They are instead shaped by history, emotion and sometimes irrelevant facts.