Working Paper: CEPR ID: DP10214
Authors: Alessandro Beber; Michael W. Brandt; Jason Cen
Abstract: Risk-off refers to a change in risk preferences and the associated portfolio rebalancing. We identify these episodes using the switch to a polarized correlation regime of foreign-exchange returns. These risk-off transitions are relatively infrequent but noticeably increasing over time, are persistent and associated with geopolitical events, and seem unrelated to changes in macroeconomic fundamentals and to volatility or average correlation shocks. Risk-off switches have very significant effects on the returns of a large number of asset classes and trading strategies, with risky and safe asset returns being penalized and favored, respectively. This evidence is consistent with a price pressure story induced by portfolio rebalancing, as we document that risk-off transitions are associated with significant changes in the positions of professional investors across different futures markets.
Keywords: currency risk premia; fx correlation; risk-off
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk-off transitions (G41) | significant negative impacts on the returns of risky assets (G12) |
| switches from a moderate to a polarized correlation regime (P39) | significant negative impacts on the returns of risky assets (G12) |
| risk-off transitions (G41) | portfolio rebalancing towards safer assets (G11) |
| probability of switching to a polarized correlation regime (C46) | significant reduction in net speculator positions in risky assets (G19) |
| risk-off transitions (G41) | increase in safer securities (G10) |
| risk-off transitions (G41) | significant changes in professional investors' positions in futures markets (G41) |