8 September 2010

RBS Risk Appetite Indicator

RBS Risk Appetite Indicators

1: RBS FX Risk Appetite Indicator 2: RBS Composite Risk Appetite Indicator

„ The FX based risk indicator (Chart 1) is back in the risk 0.5 Risk Appetite +ve 700
2 SD Risk Appetite +ve
positive territory. Historically, this indicator tends to me 0.3 500
more volatile – will demand a sustained break into the 0.1 300
1 SD

positive appetite band to validate a ‘risk-on’ bias. No -0.1

100
1 SD
significant change in other risk indicators. -100
-0.3 2 SD
-300
-0.5
-500
-0.7
-700
-0.9
-900 Risk Appetite -ve
Risk Appetite -ve
-1.1
-1100

-1.3 -1300
Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10

Source: RBS Source: RBS

3: Changes in RBS G10 Comparative Risk Indicator 4: Movement in drivers for Composite Risk Indicator
and Nominal TWI from long term average
Paul Robson
1.2
FX Strategy 30% Most Risky Currency leads to an improvement in risk appetite
JPY
+44 20 7085 6125 CHF 0.8

Absolute Δ in normalized series

20%
CAD
Δ in Nominal

paul.robson@rbs.com AUD 0.4

10%
0.0
NOK
Ankita Dudani 0% SEK NZD
EUR -0.4
FX Strategy leads to a deterioration in risk appetite
-10% Least Risky
USD
+44 20 7085 9427 GBP Currency -0.8
Em Bond Sp. MSCI Global Eq. US Corp Credit Sp. 3m EUR/USD Vol. US Swap Sp. VIX

ankita.dudani@rbs.com -20% Note: A decline in the MSCI Global equity

1w Δ 1m Δ 3m Δ
-1.3 -1.1 -0.9 -0.7 -0.5 -0.3 -0.1 0.1 index leads to a fall in the risk indictator
Δ in Risk Appetite Indicator ( appetite improves ----->)
www.rbsm.com/strategy
Source: RBS Source: RBS
 The Royal Bank of Scotland

c5: Slope of line of best fit of the G10 Comparative Risk 6: Shifts in Country’s Risk Reversal and Rate Spread
Indicator over time over 3m
40 10 Interest Rate Differential Worse Risk

RBS Risk Appetite Indicator | 8 September 2010

FX rates more sensitive to Appetite
30 risk appetite KRW
8

20
6 IDR BRL Better
AUD ZAR Risk
10
Better Risk COP
NZD Appetite

Risk Reversal
4 Appetite KRWCOP INR ZAR
0 GBP AUD BRL
NZD IDR
PHP
2 GBP PHP
-10 INR
CHF

-20 0
CHF Now
-30
-2 JPY 3m ago
JPY Worse Risk Linear (Now)
-40
Appetite Linear (3m ago)
-4
-50 -5 0 5 10 15
Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10

Source: RBS Source: RBS

7: Vol Curve Signal: Ratio 1m / 12m Implied Vols. for G- 8: EMG Weighted ATM Vol relative to G-4 Weighted 9: Aggregated Vol of Vol: 10d vol of 3m implied vol of
10 + EMG Currencies ATM Vol G10+EMG vol (weighted average)
1.8 210
2.8

1.6 2.5 180

2.2 150
1.4
Long Run Average
1.9 Long Run Average 120
1.2 1.6
2 SD 90 Long Run Average
1 SD 1.3
1.0 2 SD
60
1.0 1 SD
1 SD
0.8 2 SD 30
0.7

0
0.6 0.4
Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09
Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Sep-98 Sep-00 Sep-02 Sep-04 Sep-06 Sep-08

Source: RBS Source: RBS Source: RBS

2
The Royal Bank of Scotland

RBS Proprietary Risk Indicator

The RBS proprietary risk appetite indicator is based on the relationship between risk reversals and interest rate spreads

RBS Risk Appetite Indicator | 8 September 2010

across a range of currencies. It’s calculated by estimating a single equation ordinary least squares regression (OLS) on a
set of 12 USD bilateral exchange rate 3m risk reversals (JPY, GBP, AUD, NZD, BRL, CHF, ZAR, INR, IDR, PHP COP and
KRW) and their associated 3m interest rate spreads against the USD. The regression is estimated on a daily frequency in
chronological order. The result is a vector (nx1, where n is the number of days) of single regression coefficients. Risk
reversal data are taken from the extensive RBS proprietary FX options database and are available from 1998 to present.
The currencies modelled are those that are widely considered to be the key funder/high yielder currencies in the G10/EM
carry trade.

It is expected that any regression line of these data points is downward sloping, since the interest rate differential or swap
points reflects revaluation risk and so the risk reversal reflects the devaluation risks among other factors. The risk reversal is
however apt to adjust more rapidly than the swap points during swings in risk appetite, not least because the swap points
are anchored by central bank behaviour, while options prices should reflect quick adjustment in insurance prices against
large swings. In times of risk aversion, the slope between the risk reversal on the y-axis and the rate differential on the x axis
should turn steeper, as risk reversals for high yielding currency puts become more expensive relative to calls and the
reverse occurs for low yielders.

RBS Composite Risk Indicator

This is a simple measure comprising of standard risk variables (EM bond spread, global equities, US corporate credit
spreads, 3m EUR/USD Vol, US swap spreads and equity vol (VIX)). Series are detrended and normalized. An index is then
constructed by weighting the six series.

RBS G10 Comparative Risk Indicator

This measure compares changes in nominal trade weighted FX indices and a country’s specific measure of risk appetite.
Risk appetite is measured as a normalised weighted index of long-term corporate credit spreads, long and short-term swap
spreads, detrended equity index, detrended bond index, 3m vol against the EUR or USD, 5Y Sovereign CDS spread and
5Y CDS spreads of leading banks in the G10. A lower number implies deteriorating risk appetite.

3
The Royal Bank of Scotland

RBS Risk Appetite Indicator | 8 September 2010

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