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«This draft: April 30, 2014 Abstract We find that differences in an individual’s prenatal environment explain heterogeneity in financial risk ...»

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The Fetal Origins Hypothesis in Finance:

Prenatal Environment and Financial Risk Taking

This draft: April 30, 2014


We find that differences in an individual’s prenatal environment explain heterogeneity in financial

risk taking propensities much later in life. An exogenous increase in exposure to prenatal

testosterone, the most potent steroid hormone in humans, is related to elevated risk taking in

financial market in adulthood. We also examine birth weight, the most widely used summary measure of the early life environment. We find that those with lower birth weight are less likely to hold risky assets, but, conditional on holding risky assets, prefer more volatile equity portfolios than those with higher birth weight. This study is one of the first attempts to incorporate into finance research the fetal origins hypothesis and the notion that prenatal environment programs a fetus in the womb to have persistent behavioral characteristics. Our results contribute to the understanding of how environmental conditions and circumstances shape individuals’ behavior in financial markets.

I Introduction A large literature in economics shows the importance of the early life environment for economic outcomes much later in life. In fact, several “fetal origins” studies have shown that conditions and circumstances even before birth are of first-order importance when it comes to explaining the observed heterogeneity in individuals’ life trajectories, in particular their long-term human

and health capital. In their recent review article, Almond and Currie (2011b) go as far as asking:

“[W]hat if the nine months in utero are one of the most critical periods in a person’s life [...]?” In financial economics research, specifically related to individual investor behavior, the importance of the early life environment has received relatively limited attention. Some studies, which focus on the postnatal environment, have recently attempted to fill this void. For example, the evidence reported by Malmendier and Nagel (2011) suggests that “Depression Babies” develop more aversion to financial risk taking later in life. Cronqvist, Siegel, and Yu (2014) show that individuals who grew up during the Depression era, or in relatively less wealthy families, develop a more value-oriented investment style later in life. Chetty et al. (2011) report that the pre- school (kindergarten) environment explains some asset allocation decisions among adults, such as contributing to a 401(k) retirement savings plan and owning a home.1 In this study, we extend these efforts by examining whether differences in the prenatal, i.e., pre-birth, environment explains heterogeneity in individuals’ financial risk taking propensities much later in life. First, we examine the long-term effects of differential prenatal exposures to testosterone. We focus on testosterone as it is the most potent steroid hormone in humans, and perhaps more importantly, we can hypothesize the direction of an effect of pre-birth testosterone exposure on financial risk taking. Existing research on the effect of prenatal testosterone on risk taking has generally relied on the 2D:4D finger ratio, i.e., the ratio of the index and ring finger lengths, a noisy biomarker of pre-birth testosterone exposure, and has provided inconclusive

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pregnancies. More specifically, the “Twin Testosterone Transfer” (TTT) hypothesis predicts that, in the case of opposite sex twins, the higher level of prenatal testosterone in the amniotic fluid of a male fetus increases the pre-birth testosterone exposure of the female fetus that shares the womb with the male fetus.

Second, we study the long-term effects of differences in birth weights. While the limitations of birth weight as a summary measure of endowments at birth is increasingly well-recognized (e.g., Almond et al. (2005)), little progress has been made towards identifying a superior measure. We use a sample of identical twins to control for confounding factors, i.e., our identification strategy allows us to control for unobserved characteristics of the mother as well as the genetic make-up of the twins. It therefore ensures that the birth weight differences are driven by environmental factors (e.g., nutritional intake within the uterus) rather than by genetic factors.

The data we use for this study come from the Swedish Twin Registry (STR), the world’s largest twin registry with very detailed information on over 50,000 different same- and oppositesex twin pairs from birth cohorts dating back to the 19th century, and constitute a combination of register and survey data. These data have been matched with detailed financial data from the Swedish Tax Authority and other individual data (e.g., family structure and education data) from Statistics Sweden, and allow us to measure financial risk taking in several alternative ways, e.g., the proportion of an individual’s financial assets allocated to risky equities.

Our empirical evidence is consistent with the fetal origins hypothesis and suggests that the prenatal environment is important for an individual’s financial risk taking propensity several decades later in life. First, we find that a female with a male co-twin, i.e., an individual in the treatment group, takes significantly more risk later in life compared to a female with a female

co-twin, i.e., an individual in the control group. The economic magnitude of the effect is sizable:

A treated female allocates about 1.24 percentage points more of the financial assets to equities compared to a female in the control group (about 3% compared to the mean allocation). These treatment effects are significant also relative to the gender gap in financial risk taking (e.g.,

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significant proportion, about 39%, of the the gender gap is explained by pre-birth exposure to the testosterone hormone, suggesting that biological factors explain a sizable proportion of the gender gap in financial risk taking. We verify that intra-twin pair social interactions in adulthood cannot easily explain our results and that the effect of a male co-twin is not merely reflecting a more general male sibling effect.

Second, controlling for twin pair fixed effects, we find that those with lower birth weight, i.e., with more adverse prenatal conditions in a general sense, are less likely to hold risky assets, but, conditional on holding risky assets, prefer more volatile equity portfolios than those with higher birth weight. A one standard deviation decreases in Birth Weight (ln) increases the Portfolio Volatility by about 0.70 percentage points, or about 5% of the mean portfolio volatility (15.26%) in the entire sample. That is, those with lower birth weight select more volatile portfolios relative to those with higher birth weight. The effect of birth weight does not appear to operate through individual characteristics that also vary with birth weight (e.g., health and education), but rather through a direct effect of birth weight on financial behavior, suggesting that, e.g., nutritional intake in utero programs a fetus to specific behaviors later in life.

Our paper contributes to several pre-existing literatures in finance and economics research.

First, this is one of the first attempt to incorporate the fetal origins hypothesis into financial economics. This hypothesis has been very useful for economists’ understanding of long-term effects of the early environment on health and human capital (e.g., Almond and Currie (2011b) and Currie (2011)), and we show that it is useful also for understanding individual investors’ financial risk taking propensities later in life. Second, with a growing literature in finance having established the importance of genetics in explaining cross-sectional heterogeneity in financial risk taking (e.g., Cesarini et al. (2009), Barnea, Cronqvist, and Siegel (2010), and Cesarini et al. (2010)), the focus is shifting to a search for the environmental circumstances and life experiences that explain outcomes of interest to financial economists. Our research is one of the first attempts in finance to show that the early life environment, even pre-birth experiences in the

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a literature in the intersection of finance and neuroscience which seeks to establish causal effects of prenatal testosterone exposure, but which has provided inconclusive evidence (e.g., Apicella et al. (2008) and Coates et al. (2009), and Sapienza, Zingales, and Maestripieri (2009)). Using an different identification strategy and a large-scale field data on individuals’ asset allocations, our research has the potential to clarify the role prenatal testosterone exposure plays for risk taking behavior later in life.

The paper is organized as follows. Section II reviews related research. Section III describes our data. Sections IV and V report our results and robustness checks. Section VI concludes.

II Related Research In this section, we review the scientific evidence on which we base our hypothesis that different prenatal environments might explain heterogeneity in risk taking propensities much later in life.

We first introduce the fetal origins hypothesis which originates from medical research, and review the empirical evidence in applied economics research related to fetal programming and health capital as well as human capital later (sometimes several decades later) in an individual’s life.

We also explain our identification strategy, in particular the “Twin Testosterone Transfer” (TTT) hypothesis. Finally, we review the pre-existing empirical evidence related to at-birth endowments, proxied by birth weight, and long-term economic outcomes.

A Fetal Origins Hypothesis The fetal origins hypothesis was pioneered in medical research by Barker (1990); Barker and Robinson (1992) who argued that the intrauterine environment may program a fetus to have particular characteristics which may affect the individual in adulthood. According to this hypothesis, the effects of prenatal conditions and circumstances may be very persistent. More specifically, Barker argued that individuals who are starved or otherwise experience poor nutrition in utero are significantly more likely to become overweight as adults, possibly because of

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likely to suffer from diseases associated with obesity, including diabetes and cardiovascular-related diseases (e.g., Barker (1995)). This mechanism is called “fetal programming” and is just started to be researched and understood in depth. One possibility is that the epigenome, which may be thought of as a set of switches that cause parts of the genome to be expressed or not, is affected in a significant way by the pre-birth environment (e.g., Petronis (2010)).2 Pre-existing scientific evidence related to the fetal origins hypothesis constitutes the basis for the empirical analysis pursued in this paper, i.e., financial risk taking later in life may in part be the outcome of fetal programming.

Over the past decade, the fetal origins hypothesis has made its way from medical research into economic research. Currie and Hyson (1999) was first in economics research to conclude that the fetal origin effects were not confined only to long-term health capital, but they extend also to human capital measures, e.g., IQ and educational attainment. Studies in applied economics have used exogenous variation in factors such as nutrition, diseases, and pollution to identify causal treatment effects of the prenatal environment.

To provide only a few examples from applied economics research, the long-term effects of poor nutrition in utero have been studied using data from the Hongerwinter of 1944-45 when the Nazi Germany effectively stopped all food supplies to the Netherlands, and adult rations dropped as low as 580 kilocalories per day, and significant effects on disease rates later in life have been reported (e.g., Stein et al. (1975) and Ravelli et al. (1976)). Other studies of the long-term effects on health as well as human capital of prenatal nutrition include studies of the Phylloxera insect which asymmetrically affected available income and food resources at different vineyards in France in the late 19th century (e.g., Banerjee et al. (2010)), and studies of fasting during the Ramadan among pregnant mothers (e.g., Almond and Mazumder (2011)). Turning to studies of the prenatal effect of diseases, Almond et al. (2005) and Almond (2006) studied children to mothers who were pregnant during the influenza epidemic of 1918 in the U.S. and 2 See, e.g., Lombardo et al. (2012a) and Lombardo et al. (2012b) for recent scientific papers related to fetal programming.

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status, as well as accelerated disability rates as adults (some of these differences remaining observable in the “treated” individuals even when they were in their 80s). Others have studied the long-term treatment effects on cognitive ability of heterogeneity in pre-birth exposure to pollution such as exposure to Chernobyl fallout in Sweden (e.g., Almond et al. (2009)) and the effects on educational attainment of particulate matter (PM) in the air, which varies exogenously with the business cycle (e.g., Sanders (2012)).

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