Investor behavior in the currency option market during the COVID-19 pandemic

Abstract

This study investigates the COVID-19 pandemic's impact on investor behavior in the currency options market, emphasizing its relationship with underlying exchange rates. Using a sample of daily data from select futures continuous calls from September 22, 2016, to December 31, 2021, we introduce a novel variable, “market imperfections,” to quantify the gap between observed and theoretical currency option prices based on the Garman and Kohlhagen model. Through the application of a Markov switching model, we identify pandemic-related changes in investor behavior, characterized by patterns of divergence and convergence. Our research distinguishes between two key behavioral types in the market: fundamentalists and chartists. This study enriches the literature by clarifying how crises, specifically the COVID-19 period, influence investor dynamics and affect market responses. Overall, we provide critical insights into the factors shaping behavior during challenging periods.