Global Risk Aversion Spillover Dynamics and Investors' Attention Allocation

This paper investigates market-wide risk aversion in an international setting. Particularly, this empirical study evaluates risk aversion spillover dynamics as an uncertainty transmission mechanism for the period 2000-2015 to reveal if there has been a significant change in these dynamics when markets are going through turbulent periods. As a plausible proxy for risk aversion, variance risk premium (VRP) is computed through the difference between expected variances under risk-neutral and physical measures for seven markets studied: United States, United Kingdom, Germany, France, Netherlands, Switzerland and Japan. Effects of a shock to U.S. VRP on the other markets' VRPs are evaluated through Generalized Forecast Error Variance Decomposition. Results show that risk aversion spillovers from U.S. to other markets are stronger while the U.S. is going through turbulent periods confirming the intuition that investors are more focused on incidents in the turbulent market. Markets become more connected in terms of sentiments when a country is unexpectedly hit by a major crisis, limiting diversification opportunities.