Currency carry trade is the investment strategy that involves selling low
interest rate currencies in order to purchase higher interest rate currencies,
thus profiting from the interest rate differentials. This is a well known
financial puzzle to explain, since assuming foreign exchange risk is
uninhibited and the markets have rational risk-neutral investors, then one
would not expect profits from such strategies. That is, according to uncovered
interest rate parity (UIP), changes in the related exchange rates should offset
the potential to profit from such interest rate differentials. However, it has
been shown empirically, that investors can earn profits on average by borrowing
in a country with a lower interest rate, exchanging for foreign currency, and
investing in a foreign country with a higher interest rate, whilst allowing for
any losses from exchanging back to their domestic currency at maturity. This
paper explores the financial risk that trading strategies seeking to exploit a
violation of the UIP condition are exposed to with respect to multivariate tail
dependence present in both the funding and investment currency baskets. It will
outline in what contexts these portfolio risk exposures will benefit
accumulated portfolio returns and under what conditions such tail exposures
will reduce portfolio returns.Comment: arXiv admin note: substantial text overlap with arXiv:1303.431