Risk-On Risk-Off

Risk-On Risk-Off

Risk-on risk-off is an investment setting in which price behavior responds to and is driven by changes in investor risk tolerance. During periods when risk is perceived as low, the risk-on risk-off theory states that investors tend to engage in higher-risk investments. The 2008 financial crisis was considered a risk-off year, when investors attempted to reduce risk by selling existing risky positions and moving money to either cash positions or low/no-risk positions, such as U.S. Treasury bonds. In risk-on situations, investors have a high risk appetite and bid up the prices of assets in the market. Just like the stock market rises relating to a risk on environment, a drop in the stock market equals a risk off environment.

Risk-on risk-off is an investment paradigm under which asset prices are dictated by changes in investors' risk tolerance.

What Is Risk-On Risk-Off?

Risk-on risk-off is an investment setting in which price behavior responds to and is driven by changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns.

During periods when risk is perceived as low, the risk-on risk-off theory states that investors tend to engage in higher-risk investments. When risk is perceived to be high, investors have the tendency to gravitate toward lower-risk investments.

Risk-on risk-off is an investment paradigm under which asset prices are dictated by changes in investors' risk tolerance.
In risk-on situations, investors have a high risk appetite and bid up the prices of assets in the market.
In risk-off situations, investors become more risk-averse and sell assets, sending their prices lower.

Understanding Risk-On Risk-Off

Investors' appetites for risk rise and fall over time. At times, investors are more likely to invest in higher-risk instruments than during other periods, such as during the 2009 economic recovery period. The 2008 financial crisis was considered a risk-off year, when investors attempted to reduce risk by selling existing risky positions and moving money to either cash positions or low/no-risk positions, such as U.S. Treasury bonds.

Not all asset classes carry the same risk. Investors tend to change asset classes depending on the perceived risk in the markets. For instance, stocks are generally considered to be riskier assets than bonds. Therefore, a market where stocks are outperforming bonds is said to be a risk-on environment. When stocks are selling off and investors run for shelter to bonds or gold, the environment is said to be risk-off.

Investors invest in a risk on environment when they put their money into riskier assets.

Risk Sentiment

While asset prices ultimately detail the risk sentiment of the market, investors can often find signs of changing sentiment through corporate earnings, macroeconomic data, global central bank action and statements, and other factors.

Conversely, risk-off environments can be caused by widespread corporate earnings downgrades, contracting or slowing economic data, uncertain central bank policy, a rush to safe investments, and other factors. Just like the stock market rises relating to a risk on environment, a drop in the stock market equals a risk off environment. That's because investors want to avoid risk and are averse to it.

Returns and Risk-On Risk-Off

As the perceived risk rises in the markets, investors jump from risky assets and pile into high-grade bonds, U.S. Treasury bonds, gold, cash, and other safe havens. While returns on these assets are not expected to be excessive, they provide downside protection to portfolios during times of distress.

When risks subside in the market, low-return assets and safe havens are dumped for high-yielding bonds, stocks, commodities, and other assets that carry elevated risk. As overall market risks stay low, investors are more willing to take on portfolio risk for the chance of higher returns.

Related terms:

Asset Class

An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. read more

Bond : Understanding What a Bond Is

A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. read more

Bond Market

The bond market is the collective name given to all trades and issues of debt securities. Learn more about corporate, government, and municipal bonds. read more

Cash Position

A cash position represents the amount of cash that a company, investment fund or bank has on its books at a specific point in time. read more

Commodity

A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. read more

Credit Crisis

A credit crisis is a breakdown of a financial system caused by a severe disruption of the normal process of cash movement that underpins any economy. read more

Dash to Trash

Dash to trash refers to a situation where investors rush to invest in a class of securities or other assets, bidding up prices to beyond what is reasonably justified. read more

High-Yield Bond Spread

A high yield bond spread is the percentage difference in current yields of various classes of high-yield bonds compared a benchmark bond measure. read more

High-Yield Bond

A high-yield, or "junk" bond has a lower credit rating and thus pays a higher yield due to having more risk than higher rated bonds. read more

Investment Grade

Investment grade refers to bonds that carry low to medium credit risk. read more