Optimal currency carry trade strategies

- We solve the optimal allocation to the currency carry trade avoiding the crash risk.
- We create optimal parametric weights depending on financial variables.
- The optimal carry trade depends positively on the CRB and global monetary policy.
- It also depends negatively on the U.S. Ted spread and the U.S. AFD.
- The investor's gains are economically significant in-sample and out-of-sample.

This paper studies the optimal asset allocation problem of an investor with a portfolio given by the U.S. risk-free asset and a carry trade benchmark comprising the currencies of the G10 countries. Our optimal strategy is able to adapt to macroeconomic conditions and avoid the so-called crash risk inherent in standard carry trade strategies by constructing a vector of dynamic weights that depends on a set of state variables. We find that the U.S. Ted spread, the U.S. average forward discount, the CRB Industrial return, and a global monetary policy indicator are the key drivers of optimal currency carry trade strategies.