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Changes in Investors' Risk Appetite - An Assessment of Financial Integration and Interdependence

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Author Info

  • Laurence Fung

    (Research Department, Hong Kong Monetary Authority)

  • Chi-sang Tam

    (Research Department, Hong Kong Monetary Authority)

  • Ip-wing Yu

    (Research Department, Hong Kong Monetary Authority)

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    Abstract

    Investors' attitude towards risk is a key factor driving the movement in asset prices. Global reduction in investors' risk appetite has coincided with episodes of global financial market correction. In this paper, we derive a measure for risk appetite based on the methodology of Gai and Vause (2006) for investors in the US, the UK, Germany, Japan, and Hong Kong, and use them to help assess the issues of financial integration and financial market interdependence. Indicators are constructed to gauge the relationship between the risk appetite and the extent of financial integration between these stock markets. The results from the indicators point to very limited financial integration between these five financial markets. Furthermore, the degree of co-movement between risk appetite measures and the stock and bond market performance is examined using the dynamic conditional correlation. The empirical results reveal that there exists interdependence between the changes in the risk appetite and the stock market returns in the US, Japan and Hong Kong, while the "flight-to-quality" phenomenon is apparent in the bond market of the five economies.

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    File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP08_12_full.pdf
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    Bibliographic Info

    Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0812.

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    Length: 36 pages
    Date of creation: Aug 2008
    Date of revision:
    Handle: RePEc:hkg:wpaper:0812

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    Keywords: Risk appetite; Financial integration; Market interdependence;

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    1. Tobias Adrian, 2007. "Measuring risk in the hedge fund sector," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 13(Mar).
    2. Kpate ADJAOUTÉ & Jean-Pierre DANTHINE, 2003. "European Financial Integration and Equity Returns: A Theory-Based Assessment," FAME Research Paper Series rp84, International Center for Financial Asset Management and Engineering.
    3. Manning, Neil, 2002. "Common trends and convergence? South East Asian equity markets, 1988-1999," Journal of International Money and Finance, Elsevier, vol. 21(2), pages 183-202, April.
    4. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-50, July.
    5. Prasanna Gai & Nicholas Vause, 2006. "Measuring Investors' Risk Appetite," International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March.
    6. Lieven Baele & Annalisa Ferrando & Peter Hördahl & Elizaveta Krylova & Cyril Monnet, 2004. "Measuring financial integration in the euro area," Occasional Paper Series 14, European Central Bank.
    7. Engle, Robert F & Sheppard, Kevin K, 2001. "Theoretical and Empirical Properties of Dynamic Conditional Correlation Multivariate GARCH," University of California at San Diego, Economics Working Paper Series qt5s2218dp, Department of Economics, UC San Diego.
    8. 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.
    9. Coudert, V. & Gex, M., 2006. "Can risk aversion indicators anticipate financial crises?," Financial Stability Review, Banque de France, issue 9, pages 67-87, December.
    10. Korajczyk, Robert A., 1995. "A measure of stock market integration for developed and emerging markets," Policy Research Working Paper Series 1482, The World Bank.
    11. Haldane, A G & Hall, S G, 1991. "Sterling's Relationship with the Dollar and the Deutschemark: 1976-89," Economic Journal, Royal Economic Society, vol. 101(406), pages 436-43, May.
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