How much risk is enough? Your mileage may vary: economists at Cornell University found that former US soldiers who had fought in wars were much less likely to hold shares or unit trusts than those who hadn't seen combat. This difference cannot be explained by differences in income, wealth, marital status or education.
Instead, it suggests that exposure to danger in one context can reduce our willingness to take risks even years later in very different circumstances. "Psychological shocks affect an individual's willingness to take risks", the authors conclude.
Share market shellshock
This corroborates work by Ulrike Malmendier of the University of California at Berkeley. She says people who see shares do badly in their formative years are less likely to hold them years later than those who grew up in better times. For example, younger households in the 1980s tended not to hold shares, even if they could afford them, because the experience of the 1970s bear market heavily coloured their attitudes to the market.
Slightly older folk, who had seen the bull market of the 1950s and 1960s, were more inclined to own shares. And much older folk, who experienced the 1930s depression, were less likely to hold shares.
Because I'm worth it
It is also consistent with a theory proposed by Andrew Newell at the University of Sussex. One of the puzzles of economic history is: why did full employment not lead to inflation in the 1950s and 60s, but it did in the 70s?
Newell says it is because 1950s workers remembered the mass unemployment of the 1930s and this memory caused them to fear joblessness and accept low pay rises. However, by the 1970s a generation of workers had emerged that had known nothing but full employment. These happier experiences emboldened them to demand higher pay, with the result that inflation took off.
Are we scarred from the crisis?
All of this has a worrying implication for equity investors. It suggests that memories of a banking crisis or euro area debt crisis can have a scarring effect for years. Memories of the losses suffered since 2008, for example, can make folk reluctant to take on equity risk for many years.
When this happens, share prices might stay low for a long time, even ignoring the big and nasty likelihood that of reduced economic growth in following years.
The next generation's fresh outlook
One fact of financial history warns us of this danger: bubbles in asset prices tend to be separated by many years. UK house prices peaked in 1989 and 2007, a gap of 18 years. Bull runs in gold, in the 70s and now, have been over 30 years apart. And the three last big spikes in share prices, in 1973, 1987 and 2000, were separated by 13-14 years.
All this is consistent with the fact that investors who remember bubbles bursting are loath to buy assets for years afterwards, and it is only when younger investors without such painful memories enter the market that prices rise again. The physicist Max Planck once said that science progresses one death at a time, as men who believe in old ideas formed in their youth die. Maybe bull markets also emerge one death at a time, for similar reasons.