Does Limited Attention Drive Momentum Effect in FX Markets?

Posted: 25 Jan 2018 Last revised: 1 Jul 2022

See all articles by Calvin J. Chiou

Calvin J. Chiou

Nanyang Technological University (NTU), Nanyang Business School

Yin-Feng Gau

National Central University; National Central University

Date Written: January 16, 2018

Abstract

This paper studies the momentum effect in foreign exchange (FX) markets. We test the frog-in-the-pan (FIP) hypothesis of Da et al. (2014) in FX markets that states investor limited attention drives momentum effects. FIP-like investors underreact to information arriving continuously in gradual changes, leading to stronger momentum effects. We construct currency momentum portfolios by extending the data period studied in Menkhoff et al. (2012b). Data include 48 currencies, covering the period of 40 years. The empirical results show that the average of returns for momentum strategies are up to 15% per annum (p.a.). As we further sort momentum portfolios by information discreteness, momentum returns are up to 40% following continuous information. In contrast, momentum returns become insignificantly different from zero following discrete information. The cross-sectional regressions and robustness checks show three main conclusions as follows. First, momentum effect still exists in FX markets until 2016; Second, discrete information mitigates momentum effects due to more attraction to investors’ attention, while continuous information induces stronger momentum effects; Third, investor limited attention causes underreaction and further drives momentum effects in FX markets. The extent of FIP phenomena varies with currencies. In the currency market features, high liquidity and large transaction volume, behavioral biases are more likely to influence investors’ decision-making and lead to momentum effects.

Keywords: Limited Attention, Momentum, Foreign Exchange (FX) Markets

JEL Classification: F31, G02, G12, G14

Suggested Citation

Chiou, Jian-Jia and Gau, Yin-Feng and Gau, Yin-Feng, Does Limited Attention Drive Momentum Effect in FX Markets? (January 16, 2018). Asian Finance Association (AsianFA) 2018 Conference, Available at SSRN: https://ssrn.com/abstract=3109118

Jian-Jia Chiou

Nanyang Technological University (NTU), Nanyang Business School ( email )

50 Nanyang Avenue
Singapore, 639798
Singapore

Yin-Feng Gau (Contact Author)

National Central University ( email )

Department of Finance, National Central Univesity
300 Jhongda Rd.
Jhongli, Taoyuan 32001
Taiwan
+886-3-4227151 ext. 66263 (Phone)
+886-3-4252961 (Fax)

National Central University ( email )

Department of Finance, National Central Univesity
300 Jhongda Rd.
Jhongli, Taoyuan 32001
Taiwan
+886-3-4227151 ext. 66263 (Phone)
+886-3-4252961 (Fax)

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
221
PlumX Metrics