Risk Aversion Propagation: Evidence from Financial Markets and Controlled Experiments

63 Pages Posted: 25 May 2021

See all articles by Xing Huang

Xing Huang

Washington University in St. Louis - Olin Business School

Nancy R. Xu

Boston College, Carroll School of Management

Date Written: May 25, 2021

Abstract

While the time variation in investor risk appetite is widely examined, there is scant research on how investor risk appetite may respond in an international context. We study risk aversion (RA) propagation from US to other major developed economies using both financial market data and controlled experiments. By exploiting daily financial market and news data between 2000 and 2017, we identify US risk aversion events -- both high and low -- and show that the international pass-through of US high RA events is significantly higher (61%) than that of US low RA events (43%), suggesting asymmetric US risk aversion propagation. Next, in our experiment, non-US subjects when primed with a US financial bust shock exhibited asymmetrically lower positive emotion, higher negative emotion and higher risk aversion than those primed with a US boom shock. The foreign nature of negative shocks may change emotions more than that of positive shocks, hence resulting in asymmetric risk aversion propagation. Our evidence shows that such an ``emotion''-related mechanism explained up to 20% of the asymmetry.

Keywords: risk aversion, propagation, emotions, animal spirits, controlled experiment, VIX, variance risk premium, uncertainty, international comovement

JEL Classification: G1, G15, D91, C9

Suggested Citation

Huang, Xing and Xu, Nancy R., Risk Aversion Propagation: Evidence from Financial Markets and Controlled Experiments (May 25, 2021). Available at SSRN: https://ssrn.com/abstract=3852463 or http://dx.doi.org/10.2139/ssrn.3852463

Xing Huang

Washington University in St. Louis - Olin Business School ( email )

Simon Hall 211
Washington University in St. Louis
St. Louis, MO 63130
United States

Nancy R. Xu (Contact Author)

Boston College, Carroll School of Management ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

HOME PAGE: http://www.nancyxu.net

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