EconPapers    
Economics at your fingertips  
 

A Transaction Data Study of the Forward Bias Puzzle

Francis Breedon (), Dagfinn Rime () and Paolo Vital ()
Additional contact information
Paolo Vital: University d'Annunzio

Authors registered in the RePEc Author Service: Paolo Vitale ()

No 2010/26, Working Paper from Norges Bank

Abstract: Using ten years of FX transactions data we demonstrate that a large share of the FX forward discount bias can be accounted for by order flow. A simple microstructure-based decomposition suggests that order flow creates a timevarying risk premium that is correlated with the forward discount. The order flow related risk premium is particularly important in currency pairs traditionally associated with carry trade activity, as for these crosses it accounts for more than half of the forward bias (with the rest accounted for by systematic forecasting errors). We also find evidence that order flow is partly driven by carry trade activity, which is itself is driven by expectations of carry trade profits. However, carry trading increases currency-crash risk in that the carry-induced order flow generates negative skewness in FX returns.

Keywords: Forward Discount Puzzle; FX Microstructure; Carry Trade; Survey Data (search for similar items in EconPapers)
JEL-codes: F31 G14 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mst
Date: 2010-12-13
Note: First version:
References: Add references at CitEc
Citations View citations in EconPapers (3) Track citations by RSS feed

Downloads: (external link)
http://www.norges-bank.no/en/Published/Papers/Working-Papers/2010/WP-201026/

Related works:
Working Paper: A Transaction Data Study of the Forward Bias Puzzle (2010) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:bno:worpap:2010_26

Access Statistics for this paper

More papers in Working Paper from Norges Bank
Contact information at EDIRC.
Series data maintained by ().

 
Page updated 2014-10-29
Handle: RePEc:bno:worpap:2010_26