Risk aversion connectedness in five European countries

In this paper we compute an aggregate index of risk aversion and indices of vulnerability and the contribution to systemic risk aversion for five European countries. The variance risk premium proxies risk aversion. The contribution to the literature is twofold. First, this is the first study estimating not only the common component, but also indices of directional connectedness among variance risk premia. Second, it is the first to estimate the interconnections by means of a FIVAR model, in order to account for long memory. Our analysis indicates measures of total and directional connectedness unlike those that would be obtained with the use of a short memory VAR. These differences arise when the focus is on market turmoil periods and on forecast horizons of thirty days. Future research evaluating spillovers among long memory series can benefit from our results. Policy-makers should take these interconnections into account when adopting effective macroeconomic policies.