The evolution of systemic risk and market sentiment: the case of the Eurozone

Abstract

The purpose of this thesis is to discuss one of the main challenge that Risk Management is facing nowadays, which is the market sentiment as main actor in the financial market and driver of the investors’ perception of risk. The focus will be the analysis of the systemic risk in the Eurozone, with particular emphasis on the correlation and impact that the market sentiment has got on the investors’ attitude, contrary to what EMH theory says. Systemic risk is based primarily on the “linkage” concept, whose main causes are the herding behavior, the financial innovation and the information cascades, which create an amplification mechanism through financial institutions and also through countries. The first part of the thesis will be dedicated to the literature review of behavioral theories which are at the basis of the systemic risk and the investors’ misperception. The second part will discuss the crucial role of the systemic risk today by highlighting his behavioral dimension, his causes and the notion of contagion. After discussing the main measures of the risk and the indicators of the market sentiment, we are going to apply them by using the Eurozone’s indices as database, and we are going to show how much tricky could be to quantify the investors’ biases and to distinguish a simply random walk from a long-lived bubble. The thesis also aims to demonstrate that the market sentiment contains important information and is not random, but rather embodies a key aspect to consider in investigating financial markets.