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Changing investors' risk appetite: Reality or fiction?

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  • Miroslav Misina

Abstract

Changes in investors' risk appetite have been used to explain various phenomena in asset markets. And yet, the basis for their use is generally weak: popular indicators of changes in risk appetite typically have scant foundation in theory and give contradictory signals in practice. This has led to the views that it is a convenient ex post rationalization rather than a well-founded explanation of asset price movements. This paper starts from the premise that changing risk appetite might be a legitimate explanation, but that there is an identification problem, both theoretically and empirically. The solution offered here is based on the approach introduced by Kumar and Persaud (Kumar, M., and A. Persaud. 2002. Pure contagion and investors' shifting risk appetite: analytical issues and empirical evidence. International Finance 5: 401-36.), and on the work of Misina (Misina, M. 2003. What Does the Risk-Appetite Index Measure? Bank of Canada, Working Paper 2003-23.) who established the theoretical conditions under which that approach will correctly identify changes in risk appetite. We propose a method to implement these conditions and thus ensure that the resulting index is empirically sound. This index is then used to examine the presence of changes in risk appetite in the data, and, more generally, whether this explanation is appropriate in particular circumstances. The empirical illustration is based on a portfolio of foreign currencies, but the techniques are general and can be applied to any portfolio.

Suggested Citation

  • Miroslav Misina, 2008. "Changing investors' risk appetite: Reality or fiction?," The European Journal of Finance, Taylor & Francis Journals, vol. 14(6), pages 489-501.
    • Handle: RePEc:taf:eurjfi:v:14:y:2008:i:6:p:489-501
    DOI: 10.1080/13518470801890784
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    References listed on IDEAS

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    1. Manmohan S. Kumar & Avinash Persaud, 2002. "Pure Contagion and Investors’ Shifting Risk Appetite: Analytical Issues and Empirical Evidence," International Finance, Wiley Blackwell, vol. 5(3), pages 401-436, November.
    2. Miroslav Misina, 2003. "What does the risk-appetite index measure?," Economics Bulletin, AccessEcon, vol. 28(6), pages 1-6.
    3. Miroslav Misina, 2005. "Risk Perceptions and Attitudes," Staff Working Papers 05-17, Bank of Canada.
    4. repec:bla:intfin:v:5:y:2002:i:3:p:401-36 is not listed on IDEAS
    5. repec:ebl:ecbull:v:28:y:2003:i:6:p:a6 is not listed on IDEAS
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    Cited by:

    1. Marcello Pericoli & Massimo Sbracia, 2009. "Capital Asset Pricing Model and the Risk Appetite Index: Theoretical Differences, Empirical Similarities and Implementation Problems," International Finance, Wiley Blackwell, vol. 12(2), pages 123-150, August.
    2. Julien Chevallier & Mathieu Gatumel & Florian Ielpo, 2014. "Commodity markets through the business cycle," Quantitative Finance, Taylor & Francis Journals, vol. 14(9), pages 1597-1618, September.
    3. Mathieu Gatumel & Florian Ielpo, 2014. "Commodity Markets through the business cycle," Post-Print hal-01302479, HAL.

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