Skewness risk premia and the cross-section of currency returns

Using model-free skewness measures that exploit the asymmetry in semivariances and option data from the over-the-counter currency market, we find that buying currencies with a high skewness risk premium (SRP) and selling currencies with a low SRP generates high returns and Sharpe ratio. Asset pricing tests – which control for omitted variables and measurement errors – show that a SRP factor enters the currency pricing kernel and is central to the pricing of risks inherent in a broad currency cross-section of 60 portfolio excess returns. These results imply that skewness risk is a strong and priced source of currency risk.