Traders, managers and loss aversion in investment banking

The article raises several causes for concern. First, regulatory authorities believe there is a cause for concern with the reliance on high bonus payments, this concern rose from the fact that contingent pay was a very high proportion of total pay. The way in which they are paid can influence their decisions, as managers do not tend to become involved unless they are losing money, so many traders will not risk a transaction if it means their manager may get involved. If a trader has already made money then he is more likely to risk it in another transaction. Also the time of year may influence the decision, if a company looks like it is going to report a profit for the year then in the last couple of months it will keep things tight and be risk adverse. It also presents a contradictory quote to the main idea, as one trader said he would prefer to take a risk in the last few months.

Secondly, the concealment of losses by traders has resulted in the failure of at least one major bank, which has resulted in regulatory inventions as well as public concern about malfeasance. The amount of autonomy in the business makes it very difficult for managers to know the ins and outs of all there traders business, the relationship is based on trust and emphasis is based on cutting losses. If loss-adverse traders can evade being found out by their managers there is the potential for a spectacular collapse such as Barings, there has been other cases such as Enron where profits had been inflated and the company collapsed. The conclusion that I came to was that there is little control over the traders and that this has broader implications where the consumer are not always put first.

In decision making, loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains. Some studies suggest that losses can be as much as twice as psychologically powerful as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman .This leads to  when people evaluate a possible gain; since people prefer avoiding losses to making gains. This explains the curvilinear shape of the prospect theory utility graph in the positive domain. Conversely people strongly prefer risks that might possibly mitigate a loss (called  behavior). Loss aversion may also explain  effects. Note that whether a transaction is framed as a loss or as a gain is very important to this calculation: would you rather get a 5% discount, or avoid a 5% surcharge? The same change in price framed differently has a significant effect on consumer behavior. Though traditional economists consider this "" and all other effects of loss aversion to be completely irrational, which is why it is so important to the fields of  and . For an extreme example consider that a consumer has £1000, he would prefer to not lose the £1000 than take a chance doubling it up, the risk might be the same but the decision behind the choice is safety first.

The main limitations of this article are that it doesn’t take into account about different trading and markets. Its examples and findings are fine for traders in the London area but any conclusions this articles makes should not be included to describe other markets that has not been researched.

The article achieves what it sets out to do; it investigates the complex managerial styles with regard to traders and several problems that can be looked at to increase production were highlighted. As a consumer this article would have done little to dispel any concerns I had about the traders and the way in which they conduct their work. What would disappoint me most is their lack of determination to maximise my investment. As a student of finance I believe the article goes into to much depth about the relevant theory, personally I believe they have over complicated the issue given the fact that no set model is apparent with all the traders. The article itself is reasonable out of date given the fast changing nature of the market, this is an obstacle in itself especially as they have no quotes or data in the last few years. However given the context of the article, I agree with the fact that the data found gives cause for concern and changes to managerial practices in trader management could have significant industry effect. I would also expect companies to warrant further investigation themselves as the findings produced in this article could change the way the managers manage and the trader’s trade.