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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.