This paper examines the relation between investor sentiment and exchange rate movements. We use a unique dataset of private and institutional investors’ sentiment and discover that institutional sentiment significantly predicts returns over medium‐term horizons in the EUR/USD market. While institutional investors seem to correctly identify the medium‐run direction of this market, private investors’ sentiment emerges as a contrarian indicator at first sight, however, its predictive power fluctuates heavily and is sample dependent. Our results point towards local investors having an informational advantage in exchange rate forecasting. We test for economic relevance with a simple but realistic out‐of‐sample trading strategy which yields significant results.
Using a new variable to measure investor sentiment we show that the sentiment of German and European investors matters for return volatility in local stock markets. A flexible empirical similarity (ES) approach is used to emulate the dynamics of the volatility process by a time-varying parameter that is created via the similarity of realized volatility and investor sentiment. Out-of-sample results show that the ES model produces significantly better volatility forecasts than various benchmark models for DAX and EUROSTOXX. Regarding other international markets no significant difference between the forecasts can be observed.JEL classification: C53, G17.
This paper examines the relation between investor sentiment and exchange rate movements. We use a unique dataset of private and institutional investors' sentiment and discover that institutional sentiment significantly predicts returns over medium-term horizons in the EUR/USD market. While institutional investors seem to correctly identify the medium-run direction of this market, private investors' sentiment emerges as a contrarian indicator at first sight, however, its predictive power fluctuates heavily and is sample dependent. Our results point towards local investors having an informational advantage in exchange rate forecasting. We test for economic relevance with a simple but realistic out-of-sample trading strategy which yields significant results.
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