 Investors' attitude towards risk: what can we learn from options?Nikola Tarashev (), Kostas Tsatsaronis () and Dimitrios Karampatos BIS Quarterly Review, 2003 Abstract: Market commentators often cite changes in investors’ attitude towards risk as a possible explanation for swings in asset prices. Indeed, episodes of financial turmoil coincide with anecdotal evidence of abrupt shifts in market sentiment from risk tolerance to risk avoidance. While these shifts may be potentially driven by changes in the fundamental disposition of individual investors towards risk, they are more likely to reflect the effective risk attitude as manifested through the behaviour of currently active investors. In particular, behaviour similar to that induced by shifts in the fundamental preferences of investors over risk and return can also reflect changes in the composition of active market players or tactical trading patterns, induced by the interaction of prevailing market conditions with institutional features. Tools that track the dynamics of investors’ willingness to take risks can lead to a better understanding of the functioning of financial markets. In particular, they can contribute not only to more effective risk management from the point of view of individual institutions, but also to improved monitoring of market conditions by policymakers. This article constructs an indicator of investors’ effective aversion to risk. The indicator is obtained by comparing the statistical likelihood of future asset returns, which is estimated on the basis of historical patterns in spot prices, with an assessment of the same likelihood filtered through market participants’ effective risk preferences, which are derived from option prices. In particular, we argue that the relative size of downside risk, as assessed from the preference-weighted and the statistical vantage points, co-moves with the prevailing effective attitude of market participants towards risk. Remarkably, we find that indicators of risk attitude derived from different equity markets have a significant common component, indicating that investor sentiment transcends national boundaries. In the next two sections we first describe and motivate the methodology and then discuss the time patterns displayed by the indicator of effective risk aversion for three equity market indices. In the last section we analyse the statistical behaviour of asset prices, conditional on whether the indicator signals a high or low investor aversion to risk. The observed patterns are consistent with accounts suggesting that periods of investor retrenchment from risk-taking are also characterised by higher equity price volatility and subdued co-movement between bond and equity markets. Date: 2003 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:bis:bisqtr:0306f Access Statistics for this article BIS Quarterly Review is currently edited by Christian Upper More articles in BIS Quarterly Review from Bank for International Settlements Contact information at EDIRC. |
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