Risk Aversion Propagation: Evidence from Financial Markets and Controlled Experiments

While the time variation in investor risk appetite is widely examined, there is scant research on how investor risk appetite may respond in an international context. We study risk aversion (RA) propagation from US to other major developed economies. Using daily financial market and news data between 2000 and 2017, we identify US risk aversion events - both high and low - and show that the international pass-through of US high RA events is significantly higher (61%) than that of US low RA events (43%), suggesting asymmetric US risk aversion propagation. Next, in our lab experiment, non-US subjects when primed with a US financial bust shock exhibited asymmetrically lower positive emotion, higher negative emotion and higher risk aversion than those primed with a US boom shock. The foreign nature of bust shocks may change emotions more than that of boom shocks, hence resulting in asymmetric risk aversion propagation. Our evidence shows that such an "emotion''-related mechanism explained up to 20% of the propagation asymmetry.