Business Intelligence

A Transaction Data Study Of The Forward Bias Puzzle

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Executive Summary

Using a market microstructure analytical framework Authors 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. They 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 the decomposition the carry trade driven risk premia accounts for about 50% of the forward bias.

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