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Carry trades, order flow, and the forward bias puzzle

Breedon, Francis; Rime, Dagfinn; Vitale, Paolo
Journal article, Peer reviewed
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URI
http://hdl.handle.net/11250/2405230
Date
2016
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  • Scientific articles [1667]
Original version
Journal of Money, Credit and Banking, 48(2016)6: 1113-1134   http://dx.doi.org/10.1111/jmcb.12328
Abstract
We investigate the relation between foreign exchange (FX) order

ow and the

forward bias. We outline a decomposition of the forward bias according to which

a negative correlation between interest rate di erentials and order

ow creates a

time-varying risk premium consistent with that bias. Using ten years of data on

FX order

ow we nd that more than half of the forward bias is accounted for by

order

ow | with the rest being explained by expectational errors. We also nd

that carry trading increases currency-crash risk in that order

ow generates negative

skewness in FX returns.
Description
This is the accepted, refereed and final manuscript to the article
Publisher
Wiley
Journal
Journal of Money, Credit and Banking

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