Risk-on/risk-off: Measuring shifts in investor risk bearing capacity

Abstract

This paper defines risk-on/risk-off (RORO), an elusive terminology in pervasive use, as high frequency variation in global investor risk taking behavior. Our daily RORO index captures time-varying investor risk appetite across multiple dimensions: advanced economy credit risk, equity market volatility, funding conditions, and currency dynamics. The index exhibits risk-off skewness and fat tails, suggesting its amplifying potential for extreme, destabilizing events. Compared to other measures, our index reflects the diverse provenance of investor behavior (and therefore of risk) in a parsimonious form. Practical applications of the RORO index highlight its valuable role in understanding international portfolio reallocation and return predictability.