Risk Aversion Propagation: Evidence from Financial Markets and Controlled Experiments
63 Pages Posted: 25 May 2021
Date Written: May 25, 2021
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: Suggested Citation