The foreign exchange market : can order flow improve a currency carry trade?

Abstract

The objective of this master thesis is to examine if a currency carry trade can be improved by accounting for order flow. We construct a carry trade strategy by pairing the three highest interest rate currencies to the three lowest yielding currencies, rebalancing every month. We find that the carry trade outperforms the alternative of investing capital at the risk free rate; however the recent financial crisis inflicted great losses on the strategy. In the attempt to explain the carry trade return using order flow, we fail to find any proof of causality on a monthly basis.