Behavioural factors affecting foreign exchange futures traders: irrationality, overconfidence and bias

Loh, Kang Hern (2020) Behavioural factors affecting foreign exchange futures traders: irrationality, overconfidence and bias. [Dissertation (University of Nottingham only)]

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In this paper, the main objectives of our study are (1) To investigate the trading behaviour of different traders: speculators, hedgers and small traders in the context of the currency futures market, and (2) To determine whether traders are motivated by irrationality and bias within the context of foreign exchange futures market. Based on the theory of dispersion of belief, different traders should differ in terms of motive and informativeness, resulting in different trading behaviours. Different trading behaviour often lead to behavioural bias as well as irrational behaviour. To examine these, our research will examine how these different traders react to both return and volatility information across 6 foreign exchange futures market.

One of our key findings when comparing between different time frames in this study is that traders seem to react strongly to intra-period information compared to past period information, which indicates that foreign exchange futures traders exhibit a form of recency bias. Comparing traders’ reaction to both the spot and futures market, traders seem to primarily react to futures return while the spot market was overall less significant in explaining traders’ behaviour. Our empirical results also show that speculators and small traders react in a contrarian fashion against the general market sentiment and in a momentum fashion towards private signals as opposed to hedgers. Lastly, we found that traders tend to strongly emphasize on return information compared to volatility information, which suggests overconfidence and anchoring bias within these traders.

All of these evidences suggest that traders act based on bounded rationality and are primarily motivated by short-term information and past period information. These suggest the violation of the efficient market hypothesis and the tendency of traders to exhibit bias in trading, which will potentially be an opportunity for traders that can capitalize on them. As a result, these evidences will serve to have important implications on different group of traders like institutional and small traders seeking to speculate, hedge-motivated institutional traders seeking to replicate or counter the performance of the prevailing sentiment and regulators regulating the foreign exchange markets.

Item Type: Dissertation (University of Nottingham only)
Keywords: behavioural finance, foreign exchange futures, irrationality, bias, overconfidence, anchoring, momentum and contrarian
Depositing User: Loh, Kang
Date Deposited: 27 Feb 2020 06:05
Last Modified: 06 May 2020 10:30

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