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The CAPM and the risk appetite index; theoretical differences and empirical similarities

Author

Listed:
  • Marcello Pericoli

    (Bank of Italy, Economic Research Department)

  • Massimo Sbracia

    (Bank of Italy, Economic Research Department)

Abstract

This paper analyzes the Risk Appetite Index (RAI), a measure of investors� 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 assets� riskiness. However, by comparing the RAI with a measure of risk aversion derived from the CAPM � a model that does not require those restrictive assumptions � 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 small�a condition that is met in our sample.

Suggested Citation

  • Marcello Pericoli & Massimo Sbracia, 2006. "The CAPM and the risk appetite index; theoretical differences and empirical similarities," Temi di discussione (Economic working papers) 586, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_586_06
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    References listed on IDEAS

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    Cited by:

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    2. Prasanna Gai & Nicholas Vause, 2006. "Measuring Investors' Risk Appetite," International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March.

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    More about this item

    Keywords

    CAPM; risk aversion;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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