By Guy Kaplanski, Haim Levy

Abstract

Risk Sentiment Index (RSI), which is affected by sentiment rather than by economic factors, is suggested, after which it is empirically estimated in the U.S. and in Japan. The RSI and actual returns are negatively correlated, implying that for the whole studied period the RSI, which measures illusionary risk rather than actual risk, affects the market. Thus, professional investors do not fully exploit this irrational phenomenon. The RSI significantly varies according to the day of the week and the season. Day-of-the-week and seasonal effects in actual returns which have been documented in the past can be explained by these RSI effects. Nowadays, these two effects are well known; hence, they are at least partially exploited, as in recent years the high RSI related to these two specific effects has not been accompanied by significant negative returns. Finally, the implications of the RSI effects are not confined to investments and affect other non-financial choices.