The Effect of Investor Sentiment on Sovereign Risk Premiums
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School of Business |
Master's thesis
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Authors
Date
2017
Department
Major/Subject
Mcode
Degree programme
Information and Service Management (ISM)
Language
en
Pages
50
Series
Abstract
The question of whether investor sentiment affects asset prices has been actively debated in the finance literature. This master´s thesis examines the effect of investor risk appetite on asset returns in the market segment that has not received much attention in the existing literature; investment grade government bonds. In order to identify the impact of investor sentiment, this study controls the effects of time-varying fundamentals by focusing on the yield spreads to Germany in 10-year government bonds of other triple-A-rated Eurozone countries. The main finding of the empirical analysis is that the sovereign yield spreads are positively related to the level of risk aversion. This study applies fairly recent and novel measure for investor risk aversion, the equity variance premium that is obtained with a decomposition method developed by Bekaert and Hoerova, and Lo Duca (2013). The variance premium for European financial markets is defined as a difference between the squared VDAX index and an estimate of the conditional variance of the German stock market, the DAX index. The decomposition of the volatility index provides measures for investor risk appetite and expected stock market uncertainty which have been identified as important drivers of asset price dynamics in recent structural dynamic asset pricing literature. The results suggest that during the times of low investor risk appetite, the sovereign yield spreads to Germany increase. This finding holds for both pre- and post-crisis periods and also when the identification assumption of constant fundamental based risk premium to Germany is relaxed by controlling the differences in CDS (credit default swap) prices.Description
Thesis advisor
Kuosmanen, TimoKeywords
investor sentiment, risk-aversion, asset pricing, yield spread, government bond