Stress Testing Market Report - Risk-On, Risk-Off, Risk Up - December 2012

Dec 5, 2012

The risk-on, risk-off (RORO) behavior of markets relates to the fluctuating appetite of investors for risky assets. There are periods with optimism in the markets and higher willingness to take risk – this is risk-on. Then after a change in risk perception, risk-aversion increases, and there is a flight-to-safety; risky assets decline in price and investors buy safe-haven investments – this is risk-off. In this paper, we present a way to calculate stressed standard deviation and expected shortfall for RORO periods. We develop a case study in RiskManager where we quantify the RORO effect on risk levels for a multi-asset class portfolio. Within this case study, we demonstrate how to identify the instruments that are more sensitive to the risk-on, risk-off effect.