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Carry Trades, Order Flow, and the Forward Bias Puzzle

Francis Breedon (), Dagfinn Rime () and Paolo Vitale ()

Journal of Money, Credit and Banking, 2016, vol. 48, issue 6, 1113-1134

Abstract: We investigate the relation between foreign exchange (FX) order flow and the forward bias. We outline a decomposition of the forward bias according to which a negative correlation between interest rate differentials and order flow creates a time‐varying risk premium consistent with that bias. Using 10 years of data on FX order flow, we find that more than half of the forward bias is accounted for by order flow—with the rest being explained by expectational errors. We also find that carry trading increases currency‐crash risk in that order flow generates negative skewness in FX returns.

Date: 2016
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http://hdl.handle.net/10.1111/jmcb.12328

Related works:
Working Paper: Carry Trades, Order Flow and the Forward Bias Puzzle (2015) Downloads
Working Paper: Carry Trades, Order Flow and the Forward Bias Puzzle (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:48:y:2016:i:6:p:1113-1134

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Journal of Money, Credit and Banking is currently edited by Robert deYoung, Paul Evans, Pok-Sang Lam and Kenneth D. West

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