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A Transaction Data Study of the Forward Bias Puzzle

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  • Breedon, Francis
  • Rime, Dagfinn
  • Vitale, Paolo

Abstract

Using a market microstructure analytical framework we decompose the FX forward discount bias into elements due to time-varying risk premia (related to EBS order flow) and forecast errors derived using the Reuters survey of FX market participants. We find that both elements are significant contributors to the forward bias with risk premia being particularly important in currency pairs traditionally associated with carry trade activity. Part of order flow is driven by carry trade, and from our decomposition the carry trade driven risk premia account for about 50% of the forward bias.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7791.

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Date of creation: Apr 2010
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Handle: RePEc:cpr:ceprdp:7791

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Keywords: Carry Trade; Forward Discount Puzzle; FX Microstructure; Survey Data;

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Citations

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Cited by:
  1. Hans Jørgen Tranvåg & Dagfinn Rime, 2012. "The Flows of the Pacific: Asian foreign exchange markets through tranquility and turbulence," Working Paper Series 12412, Department of Economics, Norwegian University of Science and Technology.
  2. Brian Lucey & Grace Loring, . "Forward Exchange Rate Biasedness across Developed and Developing Country Currencies - Do Observed Patterns Persist Out of Sample?Abstract:," The Institute for International Integration Studies Discussion Paper Series iiisdp404, IIIS.
  3. Loring, Grace & Lucey, Brian, 2013. "An analysis of forward exchange rate biasedness across developed and developing country currencies: Do observed patterns persist out of sample?," Emerging Markets Review, Elsevier, vol. 17(C), pages 14-28.

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