Currency Carry Trade Performance Across Market Conditions: An Empirical Study of the G10 Currency

Abstract

This thesis investigates the performance of currency carry trades under different economic and market conditions across the G10 currencies. The carry trade is a frequently used trading method in the FX market, exploiting the interest rate differentials between currencies. The carry trade has historically generated attractive excess returns but is known to be vulnerable to heightened volatility or adverse market shifts. Using monthly exchange rate data from the past 25 years, the study constructs carry trade portfolios and examines excess returns through regime-based dummy variable regressions and continuous variable models. Regimes are using a 36-month rolling median approach to classify key indicators into “high” and “low” months, including inflation, liquidity, volatility, and recession indicators. Subsample analyses and robustness checks are carried out. The empirical results revealed limited evidence about the dynamics of carry trade profitability and the studied regimes. Most dummy-based regressions produced statistically insignificant estimates, in contrast to several prior studies reporting robust findings. Significant findings partially align with theoretical expectations: high volatility corresponds with lower carry returns, while inflation and liquidity effects vary across subsamples and specifications. This thesis contributes to the literature by providing a comprehensive study of carry trade profitability with a perspective on the stability of carry trade performance across market conditions. The lack of consistent and robust findings highlight the complex nature of currency markets and call for future research to adopt more dynamic econometric models, refined measures, and richer datasets.