FX Carry: Ranking Currencies by Interest Rates

Summary

The document explains a currency carry trade: borrow or short currencies with relatively low central bank rates and hold currencies with relatively high rates, aiming to earn the interest-rate differential. Its simple example forms a universe of 10–20 currencies, takes long positions in the three highest-rate currencies and short positions in the three lowest-rate currencies, invests unused cash at overnight rates, and rebalances monthly.

The proposed rationale is that high-rate currencies may not depreciate enough to erase their yield advantage, contrary to uncovered interest rate parity. The cited research discusses currency risk factors and reports that carry returns can diversify traditional asset portfolios. However, the strategy is exposed to global risk and can suffer during financial stress as positions unwind. The document supplies no complete performance series for the stated rules, and its research summaries vary in sample, currency universe, and risk adjustment; the apparent profitability should not be treated as guaranteed.

Key ideas

• Carry trades buy high-interest-rate currencies and fund them with low-interest-rate currencies.
• The example ranks a 10–20 currency universe by central bank rates and rebalances monthly.
• The document links carry returns to currency risk premia and deviations from uncovered interest rate parity.
• Carry may diversify stocks and bonds, but it is vulnerable to global stress and sharp unwinds.
• Published findings may change with the currency sample and risk adjustment.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.