What drives investors' behaviour in different FX market segments? : a VAR-based return decomposition analysis

We apply the Campbell-Shiller return decomposition to exchange rate returns and fundamentals in a stationary panel vector autoregression framework. The return decomposition is then used to analyse how different investor segments react to news as captured by the different return components. The results suggest that intrinsic value news are dominating for equity investors and speculative money market investors while investors in currency option markets react strongly to expected return news. The equity and speculative money market investors seem able to distinguish between transitory and permanent FX movements while options investors mainly focus on transitory movements. We also find evidence that offsetting impact on the various return components can blur the effect of macroeconomic data releases on aggregate FX excess returns