Sentiment, Asset Prices, and Systemic Risk

Abstract:     
Regulators charged with monitoring systemic risk need to focus on sentiment as well as narrowly defined measures of systemic risk. This chapter describes techniques for jointly monitoring the co-evolution of sentiment and systemic risk. To measure systemic risk, we use Marginal Expected Shortfall. To measure sentiment, we apply a behavioral extension of traditional pricing kernel theory, which we supplement with external proxies. We illustrate the technique by analyzing the dynamics of sentiment before, during, and after the global financial crisis which erupted in September 2008. Using stock and options data for the S&P 500 during the period 2002–2009, our analysis documents the statistical relationship between sentiment and systemic risk.

Number of Pages in PDF File: 31

Keywords: systemic risk, marginal expected shortfall, pricing kernel, overconfidence, optimism

JEL Classification: E61, G01, G02, G28

working papers series