The CAPM and the risk appetite index; theoretical differences and empirical similarities
AbstractThis paper analyzes the Risk Appetite Index (RAI), a measure of investorsÂ’ risk aversion proposed by Kumar and Persaud (2001, 2002). We show that the RAI distinguishes between risk and risk aversion only under theoretically restrictive assumptions on the distribution of returns and the shocks affecting assetsÂ’ riskiness. However, by comparing the RAI with a measure of risk aversion derived from the CAPM Â— a model that does not require those restrictive assumptions Â— we find that estimates are surprisingly similar. We explain this result by proving that, under a certain condition, the RAI can approximate the risk aversion parameter of a CAPM. This occurs if the ratio between the variance of the returns on assets and the variance of the riskiness of assets is sufficiently smallÂ—a condition that is met in our sample.
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Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 586.
Date of creation: Mar 2006
Date of revision:
CAPM; risk aversion;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-05-13 (All new papers)
- NEP-CFN-2006-05-13 (Corporate Finance)
- NEP-FIN-2006-05-13 (Finance)
- NEP-FMK-2006-05-13 (Financial Markets)
- NEP-UPT-2006-05-13 (Utility Models & Prospect Theory)
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