Econometric analysis of currency carry trade

Abstract

The carry trade is a popular strategy in the currency markets whereby investors fund positions in high interest rate currencies by selling low interest rate currencies to earn the interest rate differential. In this article, we first provide an overview of the risk and return profile of currency carry trade; second, we introduce two popular models, the regime-switch model and the logistic smooth transition regression model, to analyze carry trade returns because the carry trade returns are highly regime dependent. Finally, an empirical example is illustrated.