Invest in things you understand, says economist Tomáš Plíhal

19 May 2022 Jana Sosnová

After the Russian invasion of Ukraine, currency and stock markets fluctuated, but are now calm again. Price movements are influenced by investors based on information gathered mainly online. Economist Tomáš Plíhal discusses changes in the rouble exchange rate, market behaviour, and the use of Google Trends data in research.

How has the rouble exchange rate changed with the outbreak of war in Ukraine?

At the start of the war, the rouble depreciated sharply against the euro, from around 90 roubles to the euro to around 150. There was a lot of uncertainty after the Russian invasion of Ukraine began, and together with the rapid sanctions imposed by Western countries and some companies came a lot of pressure to weaken the exchange rate. However, the rouble started to strengthen again and is now even stronger than it was before the outbreak, passing the 80 roubles to the euro mark on 25 April 2022. In my opinion, this is not a completely unexpected situation, as crises in general are characterised by great uncertainty at the outset followed by a relatively rapid calming of the markets. On the other hand, such a rapid and dramatic strengthening of the rouble, which is still continuing, was probably not anticipated by most.

Why are the markets behaving in this way?

The market always behaves the way investors who trade in it behave. Simply put, it’s about classic supply and demand. Investors make decisions about buying or selling assets based on the information available to them. If nothing happens and they have no new information, most investors do not change their behaviour and the market stays relatively calm. However, as soon as a major event happens, investors react immediately. This leads to sharp price movements in different directions. Of course, large financial institutions and central banks also play a crucial role, as they have the power to influence the market significantly.

In your research, you work with data from Google Trends. Could you describe how this data can help explain market behaviour?

If an event, such as the outbreak of war in Ukraine, is important to investors, they look for information about it on the internet and follow the latest developments. Most of them use the Google search engine. This is why Google Trends is a good tool to find out what investors were most interested in at the time, and to explore the links with market reactions. This ties in with the theory of the limited attention span of investors, who do not have the capacity to analyse all information in detail.

A Google search can show us what investors were or are focusing their attention on at any given moment. In theory, they may be influenced by what news the search engine offers them through their personalised search. The same keyword can show different people different search results, but that’s another topic.

Can you give a specific example of how this data is used?

Colleagues focused, for example, on the relationship between Google Trends and global stock markets. They used the data to construct an investor sentiment index, which they used to try to explain global market fluctuations and volatility. The information value of Google Trends proved statistically significant. Moreover, this indicator revealed a stronger impact for countries that are economically open to Russia or geographically closer to it. Our Google Trends application for explaining movements in the rouble exchange rate was also able to track the statistical significance of this indicator. That being said, we were also able to find another variable that already contained this information.

Can Google Trends data predict future developments?

Some potential on that front does exist, but we often run into several problems. The main obstacle is that we don’t know in advance what keywords to track. We only get this information retrospectively. However, they do provide us with important information about an event that has already taken place, and can therefore be analysed in detail. We want to focus our future research on whether it’s possible to predict in advance what people will be searching for.

What keywords were most prominent in relation to the war in Ukraine?

It’s hard to identify any single keyword, so we work with whole groups of keywords from different categories. At the beginning of the invasion, some of the most searched keywords were related to war, Russia, Ukraine, Vladimir Putin, NATO, or economic sanctions. However, this is gradually changing, for example, by mid-April people were searching more for phrases referring to the use of chemical weapons in Ukraine.

What is the best way for investors to act when a crisis hits?

This is very individual. Everyone has their own specific preferences, a different risk tolerance, different goals, and so on. It also depends on the specific crisis, the nature of which can differ widely each time. In my opinion, it’s best not to give specific advice to everyone across the board, as for most investors this may be somewhat detrimental.

In general, I would recommend investing only in things you understand. Investors should educate themselves so that they understand what affects the value of their investments, what they can realistically expect to get in return, but also what they can expect to lose. If they understand their investments properly, then they should be prepared for various crises and not panic unnecessarily. The worst thing, in my opinion, is to invest unthinkingly according to recommendations from the media or other people.

Google Trends

This is a Google service that displays statistics for search terms in different regions and languages. Google Trends data allows you to track, for example, the keywords or terms that users search for most often. Together with social media data, they help to better understand investor behaviour and how markets react to different events.

Tomáš Plíhal has recently received Rector’s Award for Outstanding Research Results Achieved by Young Scientists under 35. He is an assistant professor at the Department of Finance, Faculty of Economics and Administration, Masaryk University. He specialises in financial markets, with a focus on quantitative finance. His research focuses on forecasting and modelling market volatility and financial risks.

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