Global Risk Appetite Index

Risk appetite of investors describes the propensity of investors to seek risky investment returns. During economci downturns investors are often characterised as more risk averse and demand higher compensation/returns on investments. During economic booms investors might be become more optimistic, more risk seeking, and therefore demand lower relative returns for equivalent risks. The degree of risk aversion is described by the Arrow-Pratt coefficient of risk aversion.

Although described by the relationship between risk and return, directly observing the risk aversion in market prices is not possible. This is generally because there is no clear differentiation between periods in which risky asset prices move because of changing risk appetites and periods in which risky asset prices move because of changes in the level of risk of each asset.

One method of decomposing the risk levels of individual assets with the risk appetite of investors is to define the movements in risk appetite as affecting the price for risk across all risk classes simultaneously (a systematic component) and any idiosyncratic changes in risk ranking as asset class specific effects. Following a shock of systemic risk, the order of price movements should be the same as the order of the ex ante (past) level of risk of the assets. The statistical dependence between returns at t and risk at t should be strong.

The risk appetite index is therefore calculated as the rank correlation between:

These should be unrelated or uncorrelated in an efficient markets, however in the event of risk appetite change at time t:

where past risk is measured as the realised rolling volatility (standard deviation) of the spot foreign exchange rates as observed at time t, over a horizon h:

and future returns:

Foreign Currency Risk Appetite Index

The following provides a global Risk Appetite Index using the returns and volatility from foreign currency positions. The currencies are their individual trends are summarised here. Foreign currencies forwards are good source of data for measuring risk appetite as they reflect real economic investment and trade positions across the global economy. Foreign exchange rates are closely linked to interest rates across countries, which in turn reflect growth, investment and inflation.

Gloabl Risk Appetite Index through to .

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