Essays on currency crash risk, carry trade returns, and sovereign bond yields

This thesis delves into the additional compensation investors seek when assuming various risks, underscoring its significance in investment strategies and policymaking. It is structured into three essays that address different aspects of returns in financial markets. The first essay explores how currency crash risk influences carry trade returns. By introducing novel risk measures based on option pricing literature, this essay demonstrates that currency crash risk plays a substantial role in carry trade returns. A comparative analysis of unhedged and crash-hedged strategies reveals a significant link between carry trade returns and currency crash risk. The second essay highlights how frictions in financial intermediation can restrict financial intermediaries' lending to carry traders and other institutions, while also reducing their own investment positions in carry trades. It focuses on the impact of financial intermediary balance sheet constraints on carry trade returns. It shows that some part of the carry trade returns is compensation for limitations on the additional risk bearing capacity of financial intermediaries. The third essay examines the consequences of the bond maintenance requirements recently introduced by the Central Bank of Türkiye. It finds that these requirements led to reduced yields on eligible bonds and influenced the sovereign bond yield curve. Additionally, it identifies non-linear relationships between eligibility discounts and the time-to-maturity of eligible assets as well as spillover effects on financial markets.