FX Carry Trade

The three-gate gauntlet · genuine only if it clears all three and survives adversarial refutation

Gate 1

Survivorship-free

immune

clean panel

Gate 2

Placebo ≥ P95

P97.3

outranked ~195 of 200 baskets

Gate 3

Cost-aware net

RF +0.99

positive net, certified

Genuine

Worst 12-month leg (RF)-0.75

−1.00 floor0

Every strategy here — winners included — loses in its worst 12 months. Depth is honest context, not the verdict.

Cleared all three gates and adversarial refutation — a market-neutral diversifier with a losing worst year, not a standalone strategy.

The carry trade goes long currencies with high interest rates and short currencies with low rates, collecting the rate differential while bearing the risk that the high-yield currencies depreciate. Lustig, Roussanov & Verdelhan (2011) frame this payoff as compensation for a common currency risk factor rather than a free lunch.

What we found

Classic carry clears the survivorship-free placebo bar (P97.3) on real spot-and-rate data, so it reflects a genuine risk premium and not noise. But it is marginal: risk-adjusted RF is only 0.99 (roughly, the lifetime net is about the size of the max drawdown), and the worst-year RF is negative (-0.75), so it loses money in its worst year. The result is also regime-concentrated — 2013-2021 net is slightly negative and essentially all of the profit comes from the wide-rate-differential 2022-2026 window, with the top 10% of months producing about 239% of net. This is a textbook crowded crash trade: a diversifying factor-leg, not a standalone strategy.

How we tested it

2013–2026 test windowmodelled liquidity-aware costssurvivorship immune

G10/EM currency spot and short-rate data, 2013-2026 (the universe is labelled "G10" but includes EM names such as MXN/ZAR/SEK that are partly absent before 2021). Realistic modelled costs.
Placebo / robustness test: real result vs random baskets or shuffled signals (real vs the 95th percentile of random)

Source: Lustig, Roussanov & Verdelhan (2011), "Common Risk Factors in Currency Markets", Review of Financial Studies
Read the paper ↗

← The Academic Audit — all 54 studies

Research, not investment advice. “Validated” factor-legs are market-neutral diversifying building blocks with a losing worst year — none is a standalone tradeable strategy. Metrics are cost-aware and modelled (not live fills); the 2005–2026 test window is out-of-sample versus the source paper. Dollar figures are not returns and are omitted by design.