How Much Investors are Willing to Pay for the Risk? Implied Risk Appetite

One of the fundamental questions encountered in finance is how much the price of risk is. Although capital asset pricing model is ingenious, it explains poorly the price of risky asset in real world. The major reason for the defect lies on the strong assumptions of rational representative investor and evident investors' utility function. Researchers have suggested several ways to operationalize empirical tests, but none of them is perfect. The aim of this paper is to answer the question about investors' willingness to pay for risk. The willingness of investors is represented by the Euler equations of consumption as a price of risk. This research suggests a method to calculate the willingness of investors, without any assumption about investors' preference and market efficiency. The proposed method, which is named as Implied Risk Appetite, shows its adequacy through the result of the empirical research which is conducted in the Korean market.