Trading the Forward Bias: Are There Limits to Speculation?
26 Pages Posted: 20 Apr 2005 Last revised: 6 Jan 2008
Date Written: 2007
In this paper we investigate whether trading the forward bias allows for economically significant excess returns. We find that bias-trading strategies can be viewed as attractive investment opportunities per se, useful diversification devices, and promising portfolio extensions for active fund managers trying to beat their benchmarks. The empirical results, which also mirror the problems arising in attempts to explain the puzzle by risk-premia, are consistent with market evidence that the bias is traded in practice. Overall, our findings suggest that limits to speculation are unlikely to provide a (stand-alone) explanation for the persistence of the forward bias.
Keywords: Exchange rates, forward bias, trading strategies, currency options, limits to speculation
JEL Classification: F31
Suggested Citation: Suggested Citation