The CAPM and the Risk Appetite Index: Theoretical Differences and Empirical Similarities

36 Pages Posted: 3 Mar 2005

Date Written: March 2006

Abstract

This paper analyzes the Risk Appetite Index (RAI), a measure of investors' risk aversion proposed by Kumar and Persaud (2001, 2002). We show that the RAI distinguishes between risk and risk aversion only under theoretically restrictive assumptions on the distribution of returns and the shocks affecting assets' riskiness. However, by comparing the RAI with a measure of risk aversion derived from the CAPM - a model that does not require those restrictive assumptions - we find that estimates are surprisingly similar. We explain this result by proving that, under a certain condition, the RAI can approximate the risk aversion parameter of a CAPM. This occurs if the ratio between the variance of the returns on assets and the variance of the riskiness of assets is sufficiently small—a condition that is met in our sample.

Keywords: CAPM, risk aversion

JEL Classification: G11, G12

Suggested Citation

Pericoli, Marcello and Sbracia, Massimo, The CAPM and the Risk Appetite Index: Theoretical Differences and Empirical Similarities (March 2006). Bank of Italy Economic Research Paper No. 586, Available at SSRN: https://ssrn.com/abstract=676055 or http://dx.doi.org/10.2139/ssrn.676055

Marcello Pericoli (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

HOME PAGE: http://www.bancaditalia.it

Massimo Sbracia

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy
+39 06 4792 3860 (Phone)
+39 06 4792 4118 (Fax)