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Benchmark Index of Risk Appetite

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  • Miroslav Misina

Abstract

Changes in investors' risk appetite have been used to explain a variety of phenomena in asset markets. And yet, popular indicators of changes in risk appetite typically have scant foundation in theory, and give contradictory signals in practice. The question is which popular indicator, if any, captures these changes. Kumar and Persaud (2002) offer an intuitively appealing argument regarding the effects of changes in risk appetite on asset prices in a portfolio, and Misina (2003) establishes the conditions under which these effects will be present. The author proposes a method that empirically implements these conditions and thus ensures that the resulting index can identify changes in risk appetite in the data. This index is then used to assess other risk appetite indexes used in practice. An example illustrates how the index can be used to help interpret price movements in foreign exchange markets.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp06-16.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 06-16.

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Length: 30 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:bca:bocawp:06-16

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Keywords: Economic models; Financial markets;

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References

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  1. Miroslav Misina, 2003. "What Does the Risk-Appetite Index Measure?," Working Papers, Bank of Canada 03-23, Bank of Canada.
  2. Kenneth A. Froot & Paul G. J. O'Connell, 2003. "The Risk Tolerance of International Investors," NBER Working Papers 10157, National Bureau of Economic Research, Inc.
  3. Kumar, Manmohan S & Persaud, Avinash, 2002. "Pure Contagion and Investors' Shifting Risk Appetite: Analytical Issues and Empirical Evidence," International Finance, Wiley Blackwell, vol. 5(3), pages 401-36, Winter.
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Cited by:
  1. Marc Boissaux & Jang Schiltz, 2010. "An Optimal Control Approach to Portfolio Optimisation with Conditioning Information," LSF Research Working Paper Series 10-09, Luxembourg School of Finance, University of Luxembourg.
  2. Virginie Coudert & Mathieu Gex, 2007. "Does Risk Aversion Drive Financial Crises? Testing the Predictive Power of Empirical Indicators," Working Papers 2007-02, CEPII research center.
  3. Marcello Pericoli & Massimo Sbracia, 2006. "The CAPM and the risk appetite index; theoretical differences and empirical similarities," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 586, Bank of Italy, Economic Research and International Relations Area.
  4. Uhlenbrock, Birgit, 2009. "Financial marketĀ“s appetite for risk: and the challenge of assessing its evolution by risk appetite indicators," Discussion Paper Series 2: Banking and Financial Studies 2009,08, Deutsche Bundesbank, Research Centre.
  5. Birgit Uhlenbrock, 2009. "Financial markets' appetite for risk - and the challenge of assessing its evolution by risk appetite indicators," IFC Bulletins chapters, Bank for International Settlements, in: Bank for International Settlements (ed.), Proceedings of the IFC Conference on "Measuring financial innovation and its impact", Basel, 26-27 August 2008, volume 31, pages 221-259 Bank for International Settlements.

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