Crash Risk in Currency Markets - A Skewness Measure Approach

Abstract

I study crash risk in currency markets by means of a proxy for global skewness, which measures the aggregate asymmetry of daily changes in spot exchange rates involved in a carry-trade portfolio. I find that this factor is priced in the cross-section of individual currencies. The premium for skewness is about 50 basis points on a monthly basis for a sample period starting in January 1995 and ending in March 2011. The weak correlation of skewness with volatility and other well-known factors demonstrates that crash risk is a fundamental and independent ingredient for the understanding of abnormal foreign investments returns. Results are robust to bid ask spreads, subsample analysis and different measures of asymmetry.