Risk appetite and macroeconomic outcomes

Abstract

This thesis examines the macroeconomic effects of risk-appetite shocks using a proxy-SVAR approach with high-frequency external instruments. While asset pricing theory assigns a central role to time-varying risk premia, identifying their causal impact on real activity remains challenging due to the endogenous response of financial indicators to macroeconomic news. Using a purified cross asset Risk-Appetite Index from Bauer et al. (2023) as an external instrument for monthly data spanning 1990-2022, we find that a one-standard-deviation in crease in risk aversion—equivalent to a 3.8 index point rise in the VIX—generates significant contractionary effects: industrial production declines by 0.66% with effects persisting for over a year, the consumer price index falls by 0.17% over 15 months, and the federal funds rate drops by 9.9 basis points at month 3, remaining below baseline for 26 months. Durable consumption exhibits a sharp 1.2% decline on impact, highlighting the credit-channel transmission. These effects are nearly double those from traditional Cholesky identification, which understates real impacts and produces implausible long-run price dynamics. Risk-appetite shocks account for 20.5% of industrial production forecast error variance at the three-month horizon under our identification. Robustness checks using the excess bond premium reveal potential contamination from other fi nancial shocks, as evidenced by puzzling long-run price reversals, validating our choice of the cross-asset risk-appetite measure. These findings underscore the importance of proper identification for understanding financial-macro linkages and establish risk-appetite fluctuations as quantitatively important drivers of business cycle dynamics.