FX Carry - Distinct source of return in the FX market

July 2016

By Christian Betz & Karsten Sloth, Jyske Capital

In this paper, we focus on Carry as the key investment strategy in the FX market and moreover the strategy that has been analysed most by academics. First we review a number of the explanations that lie at the bottom of the source of return-risk-based explanations, investor behaviour and macro-economic explanations. Then we look at return characteristics through simple approaches to the implementation of Carry, followed by a section focusing on risk and portfolio properties.


Financial investors and market players disagree whether the foreign exchange (FX) market can be considered an independent asset class in line with equities and bonds, or whether FX should instead be considered an unpleasant or welcome consequence of investments in assets in foreign currencies - i.e. a risk factor associated with investment in foreign assets. FX lacks some of the basic characteristics typical for traditional asset classes.

  • No principal is established with ownership of an expected cash flow.
  • Basically, it is a zero-sum game for the isolated FX transactions.
  • There is no expected return in connection with persistent unilateral exposure in foreign currency.

Also a series of analyses, including Meese and Rogoff (1983), conclude that FX movements can be described by a Random Walk rather than by financial models, which also makes it challenging to classify FX as an independent asset class. However, merely because FX does not meet the above descriptive characteristics, it does not rule out that investors may expect to be compensated for systematically assuming risks in the FX market. There are well-documented and well-founded investment strategies for FX based on distinct sources of return that are unique for the FX market. Carry is the most important one, but, for instance, there are also Value and Momentum. On the basis of these systematic investment strategies, investors may hold justified expectations of a positive return over time. That is a key element in the characteristics of an asset class and to us the core element in the perception of FX as an independent asset class. Whether the reward from these strategies are based on risk premiums or anomalies (excess return without assuming further risk) is still being debated by academics and practitioners - even though consensus tends towards the risk-based explanation. We use the term 'source of return', which covers investment strategies based on both a risk premium and an anomaly.