Investor Risk Appetite Research Articles

A Quantitative Analysis of Risk Premia in the Corporate Bond Market

We propose an econometric model to decompose corporate bond spreads into compensation required by investors for unpredictable future changes in the credit environment and for expected default losses. We use the model to understand whether the significant reduction in corporate bond spreads observed since the launch of the CSPP (Corporate Sector Purchase Programme) is attributable more to the fact that expansionary monetary policy measures tend to increase the risk appetite of investors and compress risk premia, or to the ability of unconventional measures to reduce expected default losses by improving investors’ expectations about the economic and financial conditions of issuers.

The effect of foreign portfolio equity and exchange rate risk on stock returns of commercial banks in Kenya

Reversals of foreign portfolio equity due to a shift in investor risk appetite may have a drastic impact on the value of shares of commercial banks hence the effect on stock returns. Uncertainties in the flow of foreign portfolio investments (FPI) result in unpredictable behaviour of stock returns in Kenya’s economy and also at the firm level. The objective of this study was to find out the effect of foreign portfolio equity and exchange rate risk on stock returns of listed commercial banks in Kenya. The target population of the study was 11 commercial banks listed on the Nairobi Securities Exchange. The study used purposive sampling technique and concentrated on 10 commercial banks. This study used a causal research design and adopted a panel data regression using the Ordinary Least Squares (OLS) method where the data included time series and cross-sectional. Hausman test was carried out and findings indicated that random effects model was preferable for this study. Results from panel estimation showed that exchange rate risk affect stock returns of listed financial institutions in Kenya. The study recommended that policies that would attract foreign portfolio investment should be pursued by commercial banks in order to enhance stock returns. Key words: Foreign portfolio equity, stock returns, exchange rate risk, commercial banks, Nairobi securities exchange, Kenya.

Bank Funding Costs for International Banks

This paper investigates the determinants of bank funding costs for a sample of internationally active banks from 2001–12. We find that changes in banks’ unsecured funding costs are associated with bank-specific characteristics such as an institution’s credit worthiness and the return on its market value, and importantly, on the level and quality of capital. Similarly, market factors such as the level of investor risk appetite, as well as shocks to financial markets—notably the US subprime crisis and the Euro Area sovereign debt crisis—have also been key drivers of the sharp rise in bank funding costs. We also find evidence that large systemically important institutions have enjoyed a funding advantage, and that this advantage has risen since the onset of the two crises. With the exception of Euro Area periphery banks, by end-2012 the rise in funding costs had generally been reversed for most major banks as a result of improvments in bank asset quality as well as steps taken to increase resilience, notably higher capitalization. Our results suggest increased capital buffers may potentially support bank lending to the real economy by reducing bank funding costs.

Risks of delayed reindustrialization

2012 was a tough year for Serbia because transition was not completed yet and the economy went sharply into reverse. Last year the accessi­on process to the EU slowed down and economic growth shrank by 2%, which is much more than expected. Deterioration of macroeconomic fundamentals during the crisis 2008-is evident. The labor market has been hit hard by the recession. The unemployment rate, which stood at 14.4% before the crisis, is gravitating around 25% during the crisis. Projections are even more discouraging, as it is expected to stabilize at 28% in the following three years. Persistently high unemployment has dampened consumption (investment and final). Now Serbia's economy is faced with the second dip of double-dip recession. Transmission mechanisms of deeply embedded structural imbalances are accelerated by global stress factors. Public sector and great majority of private sector are loss makers. Banking industry is profitable but in downturn negative prospects are affecting its deteriorating performances. Households suffer from low income and high unemployment. This paper investigates the influence of the structural imbalances on the investor's risk appetite and potentials for recovery. The analysis includes an in-depth look at Serbia's economy through several different lenses. We take a view that is both broad and deep, striving to drill down into several key issues, but mainly from business perspective. Proposed anti-crisis program has two purposes, financial consolidation and reindustrialization through expansion of commodities production (energy and food primarily) in the first stage as well as manufacturing in the second stage. The role of the state and the importance of the public sector are also taken into equation via industrial policy in energy sector. Our work is structured into four parts. The first part addresses the strategic audit of Serbia's economy. We present key macroeconomic and vulnerability indicators and adverse trends in the main sectors. The second part examines global economic prospects with a special emphasis on alternative economic models. The third part considers reindustrialization as a way of rethinking the current economic model. Finally, we put energy sector as priority one for economic recovery in the risk analysis framework in the fourth part.

Optimal Life-Cycle Portfolios for Heterogeneous Workers

Household portfolios include risky bonds, beyond stocks, and respond to permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor's risk appetite. This occurs if a small positive contemporaneous correlation between permanent labour income shocks and stock returns is matched by a realistically high variance of such shocks and/or risk aversion. Absent this combination, the typical downward sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15-30% of lifetime consumption.

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Measuring Investors' Risk Appetite

This paper proposes a method for measuring investor risk appetite based on the variation in the ratio of risk-neutral to subjective probabilities used by investors in evaluating possible future returns to an asset. Unlike other indicators advanced in the literature, our measure of market sentiment distinguishes risk appetite from risk aversion, and is reported in levels rather than changes. Implementation of the approach yields results that respond to crises and other major economic events in a plausible manner.