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.