Risk Appetite Cycle — Equity Risk Premium
**Context:
** Equity markets operate within a broader risk appetite regime that determines the direction of global capital flows.
The equity risk premium (ERP) — the excess return investors demand for holding equities over risk-free assets — expands during risk-off periods and compresses during risk-on periods.
Understanding the prevailing risk appetite regime is the first step in assessing whether the macro tailwind is supportive or adversarial for the equity asset class as a whole. **Mechanism:
** Risk appetite is measured through multiple co-moving indicators:
The VIX (implied volatility of S&P 500 options), credit spreads (high-yield and investment grade OAS), safe-haven asset flows (USD, JPY, CHF appreciation, gold demand, Treasury demand), and cross-asset correlations (equities and bonds moving together signals crisis vs. moving inversely signals normal risk regime).
When these indicators simultaneously shift toward risk-off, institutional capital rotates from equities to bonds, cash, and safe-haven currencies — often mechanically via risk-parity funds and vol-targeting strategies that reduce exposure as realized volatility rises. **Examples:
** **Example 1:
** 2020 — COVID risk-off and recovery:
In February–March 2020, the VIX spiked from 15 to 85, credit spreads blew out to 1,100bps on high yield, and equities globally fell 35% in 5 weeks as risk-off was instantaneous and synchronized.
The subsequent risk-on recovery — Fed intervention, fiscal stimulus, vaccine development — drove an 80% rally over 12 months, with VIX returning below 20 by November 2020. **Example 2:
** 2022 — Sustained risk-off:
Unlike acute risk-off events, the 2022 period was a grinding risk-off regime driven by Fed tightening.
VIX remained persistently elevated between 25–35 for most of the year.
Equities fell 20%, credit spreads widened 200bps, and safe-haven demand kept the USD at 20-year highs.
Risk-parity and vol-targeting funds systematically de-risked as equity volatility remained elevated. **Thresholds/Conditions:
** VIX >25 = risk-off regime; reduce equity exposure, expect continued volatility.
VIX <15 for >30 days = complacency/risk-on regime; conditions favorable for equities but tail-risk accumulates.
VIX spike >40 from sub-20 = acute crisis; historically a 6–18 month equity buying opportunity.
Credit HY OAS >600bps = systemic stress signal for equities.
Want to act on this signal?
Explore broker options →Barfinex is not an investment advisor. This is not financial advice.
Barfinex may earn a commission if you open an account.