Carry trade profits remain topic of debate.

• Position: YOUR LIFE

Whether you invest in stocks, bonds, commodities, or currencies, the carry trade is one of the most popular trading strategies in the currency market. Carry trade seeks to profit by borrowing currencies with low interest rates to invest in those with high interest rates. Historically, these strategies earn substantial profits, but the reason for this profitability remains a topic of debate.

According to research from the Simon Business School at the University of Rochester (N.Y.), trade costs of basic commodities and finished goods can explain the difference in interest rates and risk exposure between countries that are net importers of basic commodities and finished goods export producers. The study reveals that sorting currencies based on net exports of finished goods or basic commodities generates a substantial spread in average excess returns on carry trades and can be a marker for risk. The researchers modeled trade costs that adjust over time to match the demand for transporting goods among countries.

"Persistent differences in interest rates across countries account for much of the profitability of currency carry trade strategies. Basic commodity currencies tend to have high interest rates...