Title: Conditional skewness in currency markets
Authors: Alina Steshkova - Vienna University of Economics and Business (Austria) [presenting]
Abstract: The aim is to introduce the modeling of currency returns conditional on the interest rate differential and the real exchange rate under the assumption that FX returns are skew-t distributed. Beyond the well-known relationship between the currency risk premium and its risk factors, we document a negative effect of the interest rate differential and the real exchange rate on idiosyncratic skewness in a short-term horizon for a set of developed and emerging market currencies. The out-of-sample results reveal evidence of the predictability of idiosyncratic skewness and the ability of conditional skewness to forecast currency risk premia at the country level. The risk factor based on conditional skewness is priced across carry trade portfolios and improves the understanding of the carry trade strategy returns. Flexible modeling of the return asymmetry and fat tails provides an accurate forecast of the value-at-risk and expected shortfall, and contributes to the analysis of downside risk in the FX market.