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Risk-On Risk-Off: Its effect on the Australian stock market

TARIQ HAQUE. Risk-On Risk-Off: Its effect on the Australian stock market. What is Risk-On Risk-Off?. Risk-On: When many investors are less risk-averse and buy risky assets such as equities and sell off safe assets such as bonds

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Risk-On Risk-Off: Its effect on the Australian stock market

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  1. TARIQ HAQUE Risk-On Risk-Off: Its effect on the Australian stock market

  2. What is Risk-On Risk-Off? • Risk-On:When many investors are less risk-averse and buy risky assets such as equities and sell off safe assets such as bonds • Risk-Off: When many investors are more risk-averse and sell risky assets such as equities and buy safe assets such as bonds • A global and recent phenomenon • Events that have caused Risk-Off: • Ben Bernanke warning on US subprime crisis (July 2007) • Collapse of Lehman Brothers (September 2008) • Downgrading of US Sovereign debt (August 2011) • Ben Bernanke announcing a wind-down of QE (June 2013) • Events that have caused Risk-On: • Ben Bernanke announcing QE 1, 2,and 3 • Draghi Put speech (July 2012) University of Adelaide

  3. Implications of Risk-On Risk-Off • Intra-stock and intra-bond correlations more positively correlated • Correlations between stocks and bonds become more negatively correlated • Greater volatility in returns to an asset class • Greater importance of sector allocation within an asset class compared to security selection • Importance of Factor timing • Effect on carry trades and Long/short strategies University of Adelaide

  4. Focus of this study • What effect does Risk-On Risk-Off have on the Australian stock market? • How do we classify a Risk-Off or Risk-On market? • This is an important question as RORO often coincides with financial crises and there is a lot of capital invested in equities (due to super) University of Adelaide

  5. Data • Sample period: April 2002 – April 2013 • Weekly returns to 10-year government bonds: US, UK. Japan, Australian, European Monetary Union • Weekly returns to equity indices: S&P 500, Russell200, FTSE 100, Nikkei 225, Eurostoxx 50, Dax 30, ASX200 • Rolling correlation technique using a rolling window of 52 weeks University of Adelaide

  6. Changes in correlation over time University of Adelaide

  7. Risk-On Risk-Off in our sample University of Adelaide

  8. Average returns(%pa) in RORO vs Non-RORO periods University of Adelaide

  9. Average returns(%pa) in RORO vs Non-RORO periods University of Adelaide

  10. Conclusions • The performance of the Australian stock market is vastly different in normal conditions versus Risk-On Risk-Off conditions • Risk-On Risk-Off conditions have been in existence from July 2007 – December 2012 • Other important applications: • Foreign exchange , commodities, bonds, property • Asset allocation in superannuation funds • Forecasting Risk-On Risk-Off • Will Risk-On Risk-Off continue into the future? University of Adelaide

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