Investigating the Effect of Exchange Rate on Herd Behavior in Tehran Stock Exchange: Application of FAVAR Approach

Document Type : Research Paper

Authors

1 Department of Economics, Alborz Campus, University of Tehran, Tehran, Iran

2 Department of Economics, University of Tehran, Tehran, Iran

Abstract

In the last 10 years, we have witnessed two major crises in the Iranian exchange market. During this period, Rial has lost substantial part of its value against USD and led into many economic problems. Another observation that exists during this period is the increase in herd behavior in the stock market. The simultaneity of these phenomena brings to mind the question of whether the exchange rate can be the cause of herd behavior in the stock market. In this study, an attempt has been made to provide a suitable answer to this question by using comprehensive modeling approach based on FAVAR. In order to achieve this goal, seasonal data of 62 economic variables of Iran and the world have been used between 1380 and 1400; Also, since herd behavior is an unobservable variable, in the first step, using the method proposed by Huang and Salmon (2004), this variable was quantified, and then in the second step, the effect of the exchange rate on this variable was examined in the form of the FAVAR model. The results show that herd behavior has intensified in the stock market in the last decade and reached its peak in 2018 and 2019. Also, the results of Impulse Response Functions and Variance Decomposition analysis show that the exchange rate has a relatively high contribution in explaining the forecast error variance and for several periods it significantly leads to the increasing of herd behavior. The sensitivity analysis regarding the number of factors indicates the robustness of the results and emphasizes the positive effect of the exchange rate on the herd behavior of the stock market.

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References

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History

  • Receive Date: 15 September 2023
  • Revise Date: 12 January 2024
  • Accept Date: 27 January 2024

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