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Measuring Investors' Risk Appetite

Author

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  • Gai, Prasanna
  • Vause, Nicholas

Abstract

This paper proposes a method for measuring investor risk appetite based on the variation in the ratio of risk-neutral to subjective probabilities used by investors in evaluating possible future returns to an asset. Unlike other indicators advanced in the literature, our measure of market sentiment distinguishes risk appetite from risk aversion, and is reported in levels rather than changes. Implementation of the approach yields results that respond to crises and other major economic events in a plausible manner.

Suggested Citation

  • Gai, Prasanna & Vause, Nicholas, 2005. "Measuring Investors' Risk Appetite," MPRA Paper 818, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:818
    as

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    File URL: https://mpra.ub.uni-muenchen.de/818/1/MPRA_paper_818.pdf
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    References listed on IDEAS

    as
    1. Danthine, Jean-Pierre & Donaldson, John B., 2014. "Intermediate Financial Theory," Elsevier Monographs, Elsevier, edition 3, number 9780123865496.
    2. Owen Lamont, 1998. "Earnings and Expected Returns," Journal of Finance, American Finance Association, vol. 53(5), pages 1563-1587, October.
    3. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-676, July.
    4. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
    5. Bollerslev, Tim & Gibson, Michael & Zhou, Hao, 2011. "Dynamic estimation of volatility risk premia and investor risk aversion from option-implied and realized volatilities," Journal of Econometrics, Elsevier, vol. 160(1), pages 235-245, January.
    6. 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.
    7. Jackwerth, Jens Carsten, 2000. "Recovering Risk Aversion from Option Prices and Realized Returns," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 433-451.
    8. 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.
    9. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    10. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
    11. repec:bis:bisqtr:0306f is not listed on IDEAS
    12. repec:bis:bisqtr:0306g is not listed on IDEAS
    13. Miroslav Misina, 2003. "What does the risk-appetite index measure?," Economics Bulletin, AccessEcon, vol. 28(6), pages 1-6.
    14. Kothari, S. P. & Shanken, Jay, 1992. "Stock return variation and expected dividends : A time-series and cross-sectional analysis," Journal of Financial Economics, Elsevier, vol. 31(2), pages 177-210, April.
    15. 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.
    16. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory and Asset Prices," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 1-53.
    17. Robert R. Bliss & Nikolaos Panigirtzoglou, 2004. "Option-Implied Risk Aversion Estimates," Journal of Finance, American Finance Association, vol. 59(1), pages 407-446, February.
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    More about this item

    Keywords

    Risk appetite; market sentiment; risk-neutral pricing; risk aversion;

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G0 - Financial Economics - - General

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