Beyond Fundamentals: Investor Sentiment and Exchange Rate Forecasting

Abstract

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.