Measuring Risk Appetite from Financial Assets' Excess Returns

31 Pages Posted: 4 Oct 2013 Last revised: 19 Jul 2015

See all articles by Mathieu Gatumel

Mathieu Gatumel

University of Savoy - Institut de Recherche en Gestion et Économie (IREGE); French National Center for Scientific Research (CNRS) - Centre de Recherches Appliquées à la Gestion (CERAG)

Florian Ielpo

Université Paris I Panthéon-Sorbonne - Centre d'Economie de la Sorbonne (CES); Unigestion

Date Written: July 18, 2015

Abstract

We introduce a new meaure of risk appetite in financial markets, based on the cross sectional behavior of excess returns. Turning them into probabilities through a Markov Switching model, we define one global risk appetite measure as the cross-sectional average of the individual probabilities for each asset to be in a "risk appetite" regime. Given the probabilistic approach that comes naturally with this Markov Switching framework, we present various tests to gauge the interest of the risk appetite measure that is presented here. Using these tests we show that our index behaves well vs. various competitors, especially in out-of-sample results. We test for the information content of various assets and find that a core of asset allocation-related assets provide the best possible choice over various competing specifications.

Keywords: Risk Appetite, Cross Market Linkages, Markov Switching, Financial Crisis Prediction

JEL Classification: E44, F37, G11, G12

Suggested Citation

Gatumel, Mathieu and Ielpo, Florian, Measuring Risk Appetite from Financial Assets' Excess Returns (July 18, 2015). Available at SSRN: https://ssrn.com/abstract=2334180 or http://dx.doi.org/10.2139/ssrn.2334180

Mathieu Gatumel (Contact Author)

University of Savoy - Institut de Recherche en Gestion et Économie (IREGE) ( email )

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French National Center for Scientific Research (CNRS) - Centre de Recherches Appliquées à la Gestion (CERAG) ( email )

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Grenoble Cedex 9, 38040
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+33 4 76 28 45 78 (Phone)

Florian Ielpo

Université Paris I Panthéon-Sorbonne - Centre d'Economie de la Sorbonne (CES) ( email )

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106-112 Boulevard de l'Hôpital
Paris Cedex 13, 75647
France

Unigestion ( email )

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Switzerland

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