Essays on the impact of carry trade activity on exchange rate movements & market volatility

Average daily turnover in FX markets were raised to ;The first part of this thesis re-examines the relationship between the yen carry trade activity and the related financial variables. Although a recent study, employing structural vector autoregression methodology, finds that the U.S. stock market performance has a dominant impact in the activity of the speculative yen carry trade using monthly data, I illustrate that this finding is not robust when weekly data is introduced to the same methodology. Instead, I find that it is the fluctuations in the Japanese yen against the U.S. dollar exchange rate, rather than the interest rate spread between the two countries and the U.S. stock market performance, that determines the direction of the yen carry trade.;The second part of the thesis investigates the role of carry trade transactions on exchange rate behavior since these transactions change the supply and demand for currencies initiated by the opportunity to exploit interest rate differentials. The net position of speculators in different currency futures are used as an indicator for carry trade activity. By employing vector autoregression methodology, the results indicate that exchange rates react instantaneously to shocks in speculators' positions and Granger causality tests suggest that these positions lead to price discovery in the spot market for exchange rates. Furthermore, out-of-sample forecasts perform better than the random walk model for three of the five currencies in our sample based on root mean square and mean absolute error forecasting evaluation criteria.;The last part investigates the dynamic lagged relationship between trading activity in currency futures and exchange rate volatility in the spot market using the net positions of trader in various currency futures markets. I use weekly high-low estimate of volatility, historical volatility, and conditional volatility from the GARCH (1, 1) process. The results point that in most cases while speculators and small traders in currency futures increase volatility in the corresponding spot markets, hedgers seem to decrease it as indicated by generalized impulse response functions. Also, in most of the cases, speculators' demand for futures increase in response to increased volatility in the spot market meanwhile hedgers' demand decrease.