Carry and conditional value at risk trend: Capturing the short-, intermediate-, and long-term trends of left-tail risk forecasts

Abstract

Given the empirical evidence that investors underreact to bad news, we examine the ability of changes in the Conditional Value at Risk (CVaR) to predict the cross-section of currency excess returns. Therefore, we introduce a variable CVaR-Trend to capture the short-, intermediate- and long-term trends of CVaR forecasts. We find that the relationship between CVaR-Trend and expected G-10 currency excess returns depends on conditioning on different regimes of FX forward discount. Our results imply a novel long-short currency trading strategy, named CVaR-Trend trade, that generates high excess returns that cannot be explained by exposure to the most common currency risk factors in both funding and investment markets.