The Economic Value of Forecasting Left-Tail Risk

Abstract

The authors show that it is possible to reduce tail risk without giving up much return. The key is to forecast <i>forward</i>-looking skewness, which will facilitate the identification of a sweet spot for a mean–variance–skewness investor. In practice, forecasting skewness can help the popular low-volatility strategy to reduce tail risk without lowering the Sharpe ratio. The authors’ findings could improve the usefulness of traditional diversification, which typically lowers variance but also results in skewness loss. <b>TOPICS:</b>Volatility measures, tail risks