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Measuring investors' risk appetite

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Author Info
Prasanna Gai
Nicholas Vause
Abstract

This paper proposes a new method for measuring investor 'risk appetite'. Like other indicators in the literature, it is based on a comparison of risk-neutral probabilities of future returns with the corresponding subjective probabilities. The precise nature of the comparison is novel, however, and involves comparing probabilities across the full range of potential returns. Unlike other indicators, our measure of market sentiment distinguishes risk appetite from risk aversion, and is reported in levels rather than changes. Implementation of the approach yields results that respond to crises and other major economic events in a plausible manner.

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Paper provided by Bank of England in its series Bank of England working papers with number 283.

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Handle: RePEc:boe:boeewp:283

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  1. Owen Lamont, 1998. "Earnings and Expected Returns," Journal of Finance, American Finance Association, vol. 53(5), pages 1563-1587, October. [Downloadable!] (restricted)
  2. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July. [Downloadable!] (restricted)
  3. Marcello Pericoli & Massimo Sbracia, 2006. "The CAPM and the risk appetite index; theoretical differences and empirical similarities," Temi di discussione (Economic working papers) 586, Bank of Italy, Economic Research Department. [Downloadable!]
  4. Miroslav Misina, 2003. "What Does the Risk-Appetite Index Measure?," Working Papers 03-23, Bank of Canada. [Downloadable!]
  5. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-76, July. [Downloadable!] (restricted)
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  6. Lawrence R. Glosten & Ravi Jagannathan & David E. Runkle, 1993. "On the relation between the expected value and the volatility of the nominal excess return on stocks," Staff Report 157, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Jens Carsten Jackwerth., 1996. "Recovering Risk Aversion from Option Prices and Realized Returns," Research Program in Finance Working Papers RPF-265, University of California at Berkeley. [Downloadable!]
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  8. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51. [Downloadable!] (restricted)
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  9. Tim Bollerslev & Michael Gibson & Hao Zhou, 2004. "Dynamic estimation of volatility risk premia and investor risk aversion from option-implied and realized volatilities," Finance and Economics Discussion Series 2004-56, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  10. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February. [Downloadable!] (restricted)
  11. Kothari, S. P. & Shanken, Jay, 1992. "Stock return variation and expected dividends : A time-series and cross-sectional analysis," Journal of Financial Economics, Elsevier, vol. 31(2), pages 177-210, April. [Downloadable!] (restricted)
  12. 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. [Downloadable!] (restricted)
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This page was last updated on 2009-11-27.

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