Time Frame: Medium-Term | Update Schedule: Weekly by 11:00 PM EST on Wednesdays | Source: Citigroup, Westpac, UBS
Construction:
A handful of firms have introduced various measures of risk appetite, which tend to look at market behavior like credit spreads, equity and foreign exchange volatility, gold prices and sector relative performance (such as between defensive sectors like utilities and economically sensitive sectors like financials).
We combined three of them and normalized them into a single index. They include: Citigroup Macro Risk Index, Westpac Risk Aversion Index and UBS G10 Carry Risk Index Plus.
As the index rises, it means that investors are becoming more and more risk-seeking. An index reading of 1.0 would mean that they are the most risk-seeking possible. As the index falls, investors are becoming more and more risk-averse. An index reading of 0 would mean that everyone has gone into a bunker and stored canned goods for the next apocalypse.
This is best used as a contrary indicator, with extremely high risk tolerance being a sign of excessive optimism and poorer-than-average future market returns. This would be when the blue line on the chart moves above the red horizontal line at the 0.8 threshold.
Conversely, times of very low risk tolerance are periods of excessive pessimism and should lead to better-than-average future market performance. This would equate to times when the blue line is below the green horizontal line at the 0.2 threshold.
