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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)
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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Publisher 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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Related research
Keywords: Risk appetite; Financial integration; Market interdependence;

Find related papers by JEL classification:
C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Estimation
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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References listed on IDEAS
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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, issue Mar. [Downloadable!]
  2. Prasanna Gai & Nicholas Vause, 2006. "Measuring Investors' Risk Appetite," International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March. [Downloadable!]
  3. 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. [Downloadable!]
  4. Korajczyk, Robert A, 1996. "A Measure of Stock Market Integration for Developed and Emerging Markets," World Bank Economic Review, Oxford University Press, vol. 10(2), pages 267-89, May.
    Other versions:
  5. 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. [Downloadable!]
  6. Robert F. Engle & Kevin Sheppard, 2001. "Theoretical and Empirical Properties of Dynamic Conditional Correlation Multivariate GARCH," University of California at San Diego, Economics Working Paper Series 2001-15, Department of Economics, UC San Diego. [Downloadable!]
    Other versions:
  7. 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. [Downloadable!] (restricted)
  8. 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.
  9. Kumar, Manmohan S & Persaud, Avinash, 2002. "Pure Contagion and Investors' Shifting Risk Appetite: Analytical Issues and Empirical Evidence," International Finance, Blackwell Publishing, vol. 5(3), pages 401-36, Winter. [Downloadable!] (restricted)
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