What Drives Investors' Behaviour in Different FX Market Segments? A Var-Based Return Decomposition Analysis

36 Pages Posted: 28 Dec 2006

See all articles by Olli Castren

Olli Castren

European Central Bank (ECB)

Chiara Osbat

European Central Bank (ECB)

Matthias Sydow

European Central Bank (ECB)

Date Written: December 2006

Abstract

We apply the Campbell-Shiller return decomposition to exchange rate returns and fundamentals in a stationary panel vector autoregression framework. The return decomposition is then used to analyse how different investor segments react to news as captured by the different return components. The results suggest that intrinsic value news are dominating for equity investors and speculative money market investors while investors in currency option markets react strongly to expected return news. The equity and speculative money market investors seem able to distinguish between transitory and permanent FX movements while options investors mainly focus on transitory movements. We also find evidence that offsetting impact on the various return components can blur the effect of macroeconomic data releases on aggregate FX excess returns.

Keywords: FX return prediction, investor flows, news surprises, panel estimation, stationary VAR

JEL Classification: C23, F31, F32, G15

Suggested Citation

Castren, Olli and Osbat, Chiara and Sydow, Matthias, What Drives Investors' Behaviour in Different FX Market Segments? A Var-Based Return Decomposition Analysis (December 2006). ECB Working Paper No. 706, Available at SSRN: https://ssrn.com/abstract=952495

Olli Castren (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Chiara Osbat

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6821 (Phone)
+49 69 1344 6000 (Fax)

Matthias Sydow

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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