Evaluation of Currencies in the Foreign Exchange Market: Attitudes and Expectations of Foreign Exchange Traders

Abstract

Summary: This article examines whether there is a connection between the attitudes of traders in the foreign exchange market and their expectations of future exchange rate developments. A psychological understanding of expectations is contrasted to the prevailing economic view of rational expectations. Findings are based on a questionnaire survey of 321 foreign exchange traders in Austria, Germany, Switzerland, and the UK. Factor analyses of semantic differential ratings of currencies result in three main factors on which currencies are evaluated. Foreign exchange traders of smaller countries (Austria, Switzerland) evaluate their home currency more positively than do other traders. Positive attitudes toward a currency correlate with expectations of currency appreciation. Social Identity Theory helps to explain the observed differences in evaluations of domestic currencies. In order to better understand financial markets, the economic assumption that expectations of market participants are unbiased and rational has to be replaced by a psychology of human market expectations.