Forward Bias Trading in Emerging Markets

This paper investigates the returns to forward bias-trading in dynamic multi–currency strategies in order to empirically assess the limits to speculation hypothesis in foreign exchange markets. The results suggest that bias–trading strategies allow for economically significant excess returns, represent attractive diversification devices, and contain low downside risk. Furthermore, enriching carry–trade portfolios with emerging market currencies results in large diversification gains. Overall, the findings are in line with the widespread use of bias– trading strategies among market professionals and challenge the concept of limits to speculation as an explanation for the forward bias puzzle.