What drives investor risk aversion? Daily evidence from the German equity market

Martin Scheicher

BIS Quarterly Review, 2003

Abstract: Stock prices move as corporate earnings prospects change but they also move as investors change their aversion to risk. Aversion to risk gives rise to a risk premium, which consists of an expected extra return that investors require to be compensated for the risk of holding stocks. Option prices are a unique source of information for the estimation of risk premia. The way strike prices in option contracts distinguish between outcomes that are relatively favourable to investors and those that are relatively unfavourable allows an estimate of risk aversion to be extracted from observed option prices. This is done by comparing what is implied in option prices with the probabilities of various outcomes from a purely statistical point of view. The purpose of this special feature is to explain daily movements in the risk aversion of investors in the German stock market as reflected in option prices.2 We focus on the main German index, the Dax, which summarises the stock prices of 30 major German companies. Our data on Dax option prices consist of daily observations from December 1995 to May 2002. To explain movements in our measure of risk aversion, we examine indicators of expectations about economic growth, market volatility, credit risk premia and negative news events. We find that investors in the German equity market seem to have become increasingly risk-averse since 1998. In addition, we note that movements in US stock prices have a strong impact on this risk aversion. We complement the study of Tarashev et al (also in this Quarterly Review) in three respects. First, we analyse risk aversion at a higher frequency: we examine daily movements, while they examine monthly movements. Second, we measure risk aversion in a slightly different way – particularly in estimating statistical probabilities – thus allowing a comparison of two measures and potentially providing a sense of the robustness of option-based measures. Finally, we go a step further by attempting to identify factors that would explain the changes in risk aversion from one day to the next.

Date: 2003
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Citations: View citations in EconPapers (11)

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