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A Transaction Data Study of the Forward Bias Puzzle

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

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.

Suggested Citation

  • Vitale, Paolo & Rime, Dagfinn & Breedon, Francis, 2010. "A Transaction Data Study of the Forward Bias Puzzle," CEPR Discussion Papers 7791, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:7791
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    Cited by:

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    2. Grossmann, Axel & Simpson, Marc W., 2015. "Bid-ask spreads, deviations from PPP and the forward prediction error: The case of the British pound and the euro," The Quarterly Review of Economics and Finance, Elsevier, vol. 55(C), pages 124-139.
    3. Grossmann, Axel & Lee, Allissa A. & Simpson, Marc W., 2014. "Forward premium anomaly of the British pound and the euro," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 140-156.
    4. Brian Lucey & Grace Loring, 2012. "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.
    5. Miah, Fazlul & Altiti, Omar, 2020. "Risk premium or irrational expectations? An investigation into the causes of forward discount bias across 27 developed and developing economies forward rates," The North American Journal of Economics and Finance, Elsevier, vol. 51(C).
    6. 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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    More about this item

    Keywords

    Carry trade; Forward discount puzzle; Fx microstructure; Survey data;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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