Workplace diversity in the financial industry isn’t just good for the minority groups who have traditionally been shut out of Wall Street professions. It also produces objectively better results, according to a new study that suggests a lack of diversity makes markets dangerously inept.
A team of economists and sociologists set up fake financial markets in both Texas and Singapore, trained about 180 different participants to have equal sophistication at trading and pricing the fake assets in the fake markets, then ran 30 separate simulations. Some of the experiments featured an ethnically diverse trading team and some of them were homogeneous, with all participants pulled from the majority ethnic group.
Fake markets with diverse traders produced far more accurate prices than the ethnically homogeneous ones. Prices got more accurate by 21 percent over the course of the experiments that used diverse traders, and 33 percent less accurate when the all-white or all-asian trading groups were unleashed. The authors explained that vast performance disparity by saying that traders trust people of the same background implicitly but suspect they’re being cheated when the person on the other side of the table looks different. “It is a bit like a car buyer taking it as a given that a seller of the same ethnicity is offering a car at a fair price, but checking the blue book value if the seller is of a different ethnicity,” the New York Times’ Neil Irwin wrote.
Even the most skilled traders were not immune to the skewing effect of being surrounded by people who look like they do. “When surrounded by coethnics, even those with superior pricing skills…were likely to commit pricing errors, buying and selling above true value,” the study says. “Homogeneous markets do not correct individual errors — they preserve or even exacerbate them.”
The significance of that finding is hard to overstate. The competition that drives financial markets is supposed to protect society from the consequences of mistakes made by financial industry professionals. If someone is wrong about how a given asset class will perform in the coming weeks or years, other people in the market will find ways to profit off that wrongness, and despite day-to-day volatility the market as a whole will prove stable. But these researchers are saying that built-in protection mechanism falls apart in the absence of ethnic diversity on the trading floor. If an all-white trading profession will fail to notice mistakes in how the market is treating investment products tied to the housing market, for example, then the markets will amplify those mistakes until they bubble over and wreak havoc on even the far-distant corners of the economy that have no direct link to Wall Street or housing.
Previous research has found a similar positive link between gender diversity and business outcomes. Companies with gender-diverse boards of directors outperformed those with few or no women on their boards by a significant margin from 2006 to 2014. Gender diversity further down the org chart also boosts results, according to a study of revenues and diversity in various offices of a business services company from 1995 to 2002.
Companies with women on the board of directors are also more likely to display greater diversity at all staffing levels, suggesting a positive feedback loop between diversity among top jobs and a staff that will be less prone to the sorts of irrational professional judgments that the Texas and Singapore experiments uncovered.
The financial industry is notoriously un-diverse, of course, and some of the largest American trading firms have faced class-action suits alleging that they actively discriminated against the few women and racial minorities who make it onto their staffs. The Wall Street reform package passed in 2010 set new requirements for diversity among both financial companies and regulatory bodies, suggesting that insiders are familiar with the economic benefits diversity brings to markets.