Volatility transmitter or receiver? Investigating dynamic connectedness between the carry trade and financial markets

Abstract

By examining the connectedness of carry trade currency with stock, foreign exchange (forex), and commodity markets, the paper investigates the extent to which shocks in capital flows driven by interest-rate differentials affect financial markets. Following the framework of Diebold and Yilmaz (2012), we find that dynamic spillovers alternate between positive and negative, but, during the Covid-19 pandemic, the carry trade is the main net transmitter of volatility to all markets. Our findings confirm the ability of carry trade to increase financial vulnerability and amplify market turbulence, especially in the forex market.

Keywords

• C32
• G15