Abstract
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.
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