The out-of-sample performance of carry trades

We carry out a large-scale investigation of the reliability of the profitability of carry trade strategies, using foreign exchange data for 48 countries over 36 years, employing reality check, superior predictive ability test, and stepwise tests to correct for data-snooping bias (the factor of luck in model selection). Carry trade strategies chosen as profitable in one period are generally not profitable in an ensuing out-of-sample sample period, especially after correcting for data-snooping and even after allowing for learning and stop-loss strategies. Any evidence of consistency in carry trade profitability that is found is concentrated in a relatively brief historical period, 1998-2005. We further investigate particular currency pairs that may drive the out-of-sample profitability during this period, and find their performance to be unstable in general. Our findings thus highlight the instability and the importance of chance or luck in generating profits from carry trades.