Contrarian strategy and overreaction in foreign exchange markets

This paper investigates patterns to assist investors to forecast future exchange rate movements. We test for overreaction and underreaction examining exchange rate changes following excess 1-day fluctuations for currencies in two emerging (Turkey, Brazil) and two developed (US, UK) countries. Using euro as the base currency, we identify that the Turkish lira, the Brazilian real and the US dollar overreact, while the British pound underreacts. In the case of British pound, asymmetric responses and lack of volatility are two crucial factors to reject overreaction. Also, we find that contrarian strategy can be used in all currency markets for profitable investments.