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Can we predict currency momentum crashes?

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  • Mario Cerrato
  • Zhekai Zhang

Abstract

We report robust empirical evidence that currency momentum crash is predictable. We show that the payoff of a currency momentum strategy has a time-varying beta structure and is linked to the carry trade factor (HML) proposed by Lustig et al. (2011). The currency momentum beta to HML is conditioned on the previous and contemporaneous HML portfolio returns. This risk pattern introduces a written call-option-like payoff in currency momentum strategies. In particular, when carry trade is recovering from previous crashes, momentum strategies lose money. We propose two currency momentum strategies to mitigate momentum crash risk.

Suggested Citation

  • Mario Cerrato & Zhekai Zhang, 2019. "Can we predict currency momentum crashes?," Working Papers 2019_12, Business School - Economics, University of Glasgow.
    • Handle: RePEc:gla:glaewp:2019_12
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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