What does the risk-appetite index measure?
Explanations of changes in asset prices as being due to exogenous changes in risk appetite assume that changes in asset prices due to changes in risk aversion can be uniquely identified, and that some quantitative measure can capture these in isolation. One such measure, the risk-appetite index, is based on the rank correlation between assets' riskiness and excess returns. The author seeks to provide a theoretical foundation for this measure. The arguments behind the index are given in two propositions and these are derived within a class of well-specified asset-pricing models. His results indicate that, whereas the exclusive attribution of the rank effect to changes in risk aversion is problematic in general, a specific set of circumstances can be identified in which this attribution is permissible. The key assumption is identified, and its empirical implications are examined.
Volume (Year): 28 (2003)
Issue (Month): 6 ()
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- Jean-Pierre Danthine & John B. Donaldson & Christos Giannikos & Hany Guirguis, 2002.
"On the Consequences of State Dependent Preferences for the Pricing of Financial Assets,"
Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP)
02.17, Université de Lausanne, Faculté des HEC, DEEP.
- Danthine, Jean-Pierre & Donaldson, John B. & Giannikos, Christos & Guirguis, Hany, 2004. "On the consequences of state dependent preferences for the pricing of financial assets," Finance Research Letters, Elsevier, vol. 1(3), pages 143-153, September.
- Danthine, Jean-Pierre & Donaldson, John B & Giannikos, Chrisos & Guirguis, Hany, 2003. "On the Consequences of State Dependent Preferences for the Pricing of Financial Assets," CEPR Discussion Papers 3697, C.E.P.R. Discussion Papers.
- Jean-Pierre Danthine & John B. Donaldson & Christos Giannikos & Hany Guirguis, 2004. "On the Consequences of State Dependent Preferences for the Pricing of Financial Assets," FAME Research Paper Series rp73, International Center for Financial Asset Management and Engineering.
- 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.
- Miroslav Misina, 2003. "Are Distorted Beliefs Too Good to be True?," Working Papers 03-4, Bank of Canada.
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