Carry Trades, Order Flow and the Forward Bias Puzzle

60 Pages Posted: 15 Aug 2015

See all articles by Francis Breedon

Francis Breedon

University of London, Queen Mary - School of Economics and Finance

Dagfinn Rime

BI Norwegian Business School

Paolo Vitale

G. d'Annunzio University - Dipartimento di Economia

Date Written: August 13, 2015

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 ten 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.

Keywords: Forward Premium Puzzle, FX Microstructure, Carry Trade, Survey Data

JEL Classification: F31, G14, G15

Suggested Citation

Breedon, Francis and Rime, Dagfinn and Vitale, Paolo, Carry Trades, Order Flow and the Forward Bias Puzzle (August 13, 2015). Available at SSRN: https://ssrn.com/abstract=2643531 or http://dx.doi.org/10.2139/ssrn.2643531

Francis Breedon

University of London, Queen Mary - School of Economics and Finance ( email )

Mile End Road
London, E1 4NS
United Kingdom

Dagfinn Rime (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway
+47-46410507 (Phone)

HOME PAGE: http://home.bi.no/dagfinn.rime/

Paolo Vitale

G. d'Annunzio University - Dipartimento di Economia ( email )

I-65127 Pescara, Pescara
Italy
+39 085 453 7647 (Phone)
+39 085 453 7565 (Fax)

HOME PAGE: http://www.unich.it/~vitale/

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