A Measure of Risk Appetite for the Macroeconomy
64 Pages Posted: 22 Nov 2016 Last revised: 29 Nov 2018
Date Written: November 29, 2018
We propose a new measure of the economy’s risk appetite based on the valuation of volatile stocks. Unlike proxies for risk appetite derived from aggregates, our measure is strongly correlated with safe asset prices and future economic activity. When our measure is high, safe bonds fall in value and risky assets rally, forecasting a boom in investment. Risk appetite is closely linked to investors' expectations of future risk and rises following positive macroeconomic outcomes. Periods of elevated risk appetite are predictably followed by upward revisions in expectations of risk, suggesting that these expectations may not be rational.
Keywords: risk-centric business cycles, cross-section of equities, real risk-free rate, real investment
JEL Classification: E120, E220, E430, E440, G120, G400
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