A Measure of Risk Appetite for the Macroeconomy

64 Pages Posted: 22 Nov 2016 Last revised: 29 Nov 2018

See all articles by Carolin E. Pflueger

Carolin E. Pflueger

University of British Columbia (UBC) - Division of Finance; National Bureau of Economic Research (NBER)

Emil Siriwardane

Harvard Business School - Finance Unit; Office of Financial Research

Adi Sunderam

Harvard Business School

Date Written: November 29, 2018

Abstract

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

Suggested Citation

Pflueger, Carolin E. and Siriwardane, Emil and Sunderam, Adi, A Measure of Risk Appetite for the Macroeconomy (November 29, 2018). Available at SSRN: https://ssrn.com/abstract=2873688 or http://dx.doi.org/10.2139/ssrn.2873688

Carolin E. Pflueger

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Emil Siriwardane (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Adi Sunderam

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

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