Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/209971 
Year of Publication: 
2010
Series/Report no.: 
Working Paper No. 2010/26
Publisher: 
Norges Bank, Oslo
Abstract: 
Using ten years of FX transactions data we demonstrate that a large share of the FX forward discount bias can be accounted for by order flow. A simple microstructure-based decomposition suggests that order flow creates a timevarying risk premium that is correlated with the forward discount. The order flow related risk premium is particularly important in currency pairs traditionally associated with carry trade activity, as for these crosses it accounts for more than half of the forward bias (with the rest accounted for by systematic forecasting errors). We also find evidence that order flow is partly driven by carry trade activity, which is itself is driven by expectations of carry trade profits. However, carry trading increases currency-crash risk in that the carry-induced order flow generates negative skewness in FX returns.
Subjects: 
FX microstructure
forward discount puzzle
carry trade
survey data
JEL: 
F31
G14
G15
Persistent Identifier of the first edition: 
ISBN: 
978-82-7553-583-0
Creative Commons License: 
cc-by-nc-nd Logo
Document Type: 
Working Paper
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