The CAPM and the risk appetite index; theoretical differences and empirical similarities
This paper analyzes the Risk Appetite Index (RAI), a measure of investorsï¿½ risk aversion proposed by Kumar and Persaud (2001, 2002). We show that the RAI distinguishes between risk and risk aversion only under theoretically restrictive assumptions on the distribution of returns and the shocks affecting assetsï¿½ riskiness. However, by comparing the RAI with a measure of risk aversion derived from the CAPM ï¿½ a model that does not require those restrictive assumptions ï¿½ we find that estimates are surprisingly similar. We explain this result by proving that, under a certain condition, the RAI can approximate the risk aversion parameter of a CAPM. This occurs if the ratio between the variance of the returns on assets and the variance of the riskiness of assets is sufficiently smallï¿½a condition that is met in our sample.
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