Can Traders Benefit from the Currency Carry Trade during Crisis Periods? An Empirical Study of Dynamic Carry Trades Developed Using VIX and VXY

Sofie Skovsgaard Mogensen & Nina Chaikhot Nielsen

Student thesis: Master thesis


Carry investors exploit interest rate differentials by going long on the currencies with a high-interest rate and short the currencies with a low-interest rate. The profitability of the strategy is well-documented, but the real picture is more complex. The findings of this thesis showed that the carry trade generated a positive return up to 2.98% per annum over the period from June 1999 to May 2020. Over the period the performance has alternated between periods of profitability as well as periods of large losses. Crisis periods appear to be the main reason for sudden and large negative returns. During the financial crisis carry investors lost up to 20% on their invested capital. The focal question of this thesis is, therefore, whether it is possible to improve upon the carry trade during volatile periods. This is investigated using the implied volatility indices VIX and VXY to time the currency carry trade strategies. Applying different dynamic carry trade strategies, which take alternative positions during volatile periods, it turns out that the performance of strategies rebalanced monthly generally improved over the full sample period and across different sub-periods. In fact, one of the alternative strategies generated a positive return up to7.23%. As most of the impact can be contributed to the improvement observed over the financial crisis, excluding this period from the analysis would have led to worse performance for some of the strategies. Hence, the findings of this cast doubt on the actual improvement obtained from the implementation of the implied volatility as a timing signal.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2020
Number of pages173