Investor sentiments and exchange rate volatility

Abstract

In this paper, we have investigated the role of investor sentiments on the exchange rate volatility in our emerging market. In the past there were many studies that tried to capture the impact of investor sentiments on the stock market returns but the exchange rates are also one of the important economic indicators and is frequently used as the stock market returns and interest rates etc, so we have tried to see the impact of investor sentiments on the exchange rate volatility. The data has been collected from International Monetary Fund website, Karachi Stock Exchange for stock returns and for the purpose to collect various sentimental proxies to measure sentimental index. Also we have not collected exchange rate data in relation to a single base currency rather we have selected a basket of currency i.e., SDR composing mainly of currencies like US dollar, Japanese Yen, Swiss Franc, Pound and Mexican Lira. For empirical testing we have used the sentiment equation mainly composing of six sentimental proxies that are dividend premium, number of initial public issues in a single year, closed end mutual fund discount, first day return on initial public offering, share turnover in Karachi Stock Exchange and equity share in total equity and long term debt issuance. We have run regression on the exchange rate volatility and independent variable was investor sentiment that we have used described above. Before that we also had applied Augmented Dickey Fuller test to check the stationarity and we have applied first differencing to make the time series stationary as in the first level place the series was unit root. Final results confirmed that the investor sentiments did explain the volatility in the exchange rates although the impact is low suggesting that there may be many other factors that explains the variation in the exchange rates. Introduction