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

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.