Carry trades, order flow, and the forward bias puzzle
Journal article, Peer reviewed
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OriginalversjonJournal of Money, Credit and Banking, 48(2016)6: 1113-1134 http://dx.doi.org/10.1111/jmcb.12328
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.
This is the accepted, refereed and final manuscript to the article