RORO
Tue, Apr 15RORO stands for “Risk On, Risk Off.” It refers to a market condition where price movements are influenced by shifts in the risk appetite of investors and traders. These changes in risk tolerance typically arise from sudden alterations in the global economic outlook.
Historically, financial assets were assessed individually based on their specific attributes, leading to mostly independent price movements. However, in the RORO era, this has evolved.
Financial assets are now categorized into two groups: low-risk and high-risk. When market sentiment is optimistic, participants activate their risk appetite and invest in riskier asset classes. This means that during times of perceived low risk, traders are inclined to purchase higher-risk assets (“risk on”). Conversely, when risk is viewed as high, traders tend to sell off high-risk assets in favor of lower-risk investments (“risk off”). Thus, if optimism shifts to pessimism, market participants switch to a more cautious stance, retreating into safer asset classes.
This shift has led to increased correlation among assets, either positively or negatively, rather than their previous independent movements.
Here’s a quick reference for which assets are favored or avoided during “risk on” and “risk off” conditions:
| Environment | Long | Short or Avoid |
|---|---|---|
| Risk On | Stocks Commodity Currencies (AUD, CAD, NZD) EM Currencies Energy Commodities | Bonds U.S. dollar Japanese yen Swiss Franc Non-Commodity Currencies |
| Risk Off | High-Quality Bonds (U.S. Treasuries) U.S. dollar Japanese Yen Swiss Franc | Stocks Commodities Non-Commodity Currencies (AUD, CAD, NZD) EM Currencies |
The concept of RORO is rooted in the conflict between inflationary and deflationary pressures. When inflationary trends are perceived to be strengthening, the market goes “risk on.” Conversely, when deflationary trends are seen as gaining traction, the market shifts to “risk off.”
The impact of the “Risk On, Risk Off” dynamic results in heightened volatility and, crucially, increased asset correlation. Since the Great Financial Crisis of 2008, there has been a noticeable trend among market participants, especially institutional investors and traders, to adopt a “risk on” stance when inflation is anticipated and to go “risk off” when deflation is expected.
This collective behavior among large financial institutions, hedge funds, and traders engaging in similar trades has led to the phenomenon known as the “RORO Trade.” This mass movement into or out of asset classes has caused many assets to become highly correlated.
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