"The average forward discount of the dollar against developed market currencies is the best predictor of average foreign currency excess returns earned by U.S. investors on a long position in a large basket of foreign currencies and a short position in the dollar. The predicted excess returns...

We describe a novel currency investment strategy, the `dollar carry trade,' which delivers large excess returns, uncorrelated with the returns on well-known carry trade strategies. Using a no-arbitrage model of exchange rates we show that these excess returns compensate U.S. investors for taking...