Do Carry Trades in the Foreign Exchange Markets Influence Stock Prices

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Carry trades have been shown to lead to significant changes in foreign exchange markets by producing shocks to interest rate differentials. This study uses fundamentals and the chartist model for the foreign exchange markets in which market participants can choose to become carry traders. It shows that carry trades play an important role in determining foreign exchange rates. Carry trades can influence exchange rates (Japanese yen and Euro against the US dollar). Also, the relationship between carry trades and three stock prices are examined empirically. As the rate of carry trades increases, stock prices in Japan and Germany rise. However, during the period of the Lehman shock, the increasing rate of carry trades may have caused a decline in Japanese stock prices, and huge amounts of money were reported to have been invested in carry trades at that time using interest rate differentials. Massive capital for carry trades seem to have been flown into foreign currencies (ex, FX) rather than stocks.

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