We carried out the dynamic vulcanization of poly(butylene terephthalate) (PBT) with ethylene rubber having an epoxy group and investigated the morphology-mechanical properties relationship. The curing agent for the rubber used was adipic acid (AA). The AA-loaded (0.1 phr) 50/50 PBT/rubber blend had a two-phase structure of densely dispersed rubber particles in a PBT matrix and it showed excellent elastic behaviour, i.e. strain recovery after large deformation. To understand the elastic character, we constructed a two-dimensional model with five rubber inclusions in a PBT matrix and carried out an elastic-plastic analysis on the deformation mechanism by the finite-element method (FEM). FEM analysis revealed that, even in the highly deformed states in which almost the whole matrix has yielded due to the stress concentration, the ligament matrix between rubber inclusions in the stretching direction is preserved within the elastic limit to form an elastic field by interconnecting cured rubber particles. The tensile dilatometry test and transmission electron microscopy observation clearly showed internal cavitation of rubber particles. Insufficient strain recovery seems to be caused by the cavitation.