Benchmark Index of Risk Appetite
Changes in investors' risk appetite have been used to explain a variety of phenomena in asset markets. And yet, popular indicators of changes in risk appetite typically have scant foundation in theory, and give contradictory signals in practice. The question is which popular indicator, if any, captures these changes. Kumar and Persaud (2002) offer an intuitively appealing argument regarding the effects of changes in risk appetite on asset prices in a portfolio, and Misina (2003) establishes the conditions under which these effects will be present. The author proposes a method that empirically implements these conditions and thus ensures that the resulting index can identify changes in risk appetite in the data. This index is then used to assess other risk appetite indexes used in practice. An example illustrates how the index can be used to help interpret price movements in foreign exchange markets.
|Date of creation:||2006|
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References listed on IDEAS
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- 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.
- 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 401-436, Winter.
- Miroslav Misina, 2003.
"What Does the Risk-Appetite Index Measure?,"
Staff Working Papers
03-23, Bank of Canada.
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