This dissertation is in the form of one survey paper and three essays on the topic of volatility. The unifying feature that permeates the entire thesis is the focus on the measurement and use of conditional second moment of equities and currencies as a measure of risk for asset pricing and policy purposes in the context of international markets. / The survey examines selected papers from the international finance literature and from the volatility literature with a focus on the theoretical and empirical relationship between first and second unconditional and conditional moments of domestic and international asset returns. It then specifically proposes several areas for investigation related to international finance topics. The first essay investigates the importance of asymmetric volatility when computing the risk premium of international assets. The results indicate that conditional second moment asymmetry is significant and time-varying. They also show that, if the price of risk is time-varying, the world market and foreign exchange risk premia estimated without allowing for time-varying asymmetry are less consistent with the data. Furthermore, they imply that asymmetry is more pronounced when the business condition is such that investors require higher compensation to bear risk. / In the second essay we start from the consideration that financial decision makers often consider the information in currency option valuations when making assessments about future exchange rates. The purpose of this essay is then to systematically assess the quality of option based volatility, interval and density forecasts. We use a unique dataset consisting of over 10 years of daily data on over-the-counter currency option prices. We find that the implied volatilities explain a large share of the variation in realized volatility. Finally, we find that wide-range interval and density forecasts are often misspecified whereas narrow-range interval forecasts are well specified. / In the third essay we examine whether the information contained in various measures of correlation among exchange rates can be used to assess future currency co-movement. We compare option-implied correlation forecasts from a dataset consisting of over 10 years of daily data on over-the-counter currency option prices to a set of return-based correlation measures and assess the relative quality of the correlation forecasts. We find that while the predictive power of implied correlation is not always superior to that of returns based correlations measures, it tends to provide the most consistent results across currencies. Predictions that use both implied and returns-based correlations generate the highest adjusted R2's, explaining up to 42 per cent of the realized correlations.

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The first essay, "Market Integration and Side by Side Trading of Derivative and Cash Instruments" inquires into the microstructure of integrated trading of derivative and cash instruments and proposes a spatial differentiation model as a framework for analysis. The model illustrates that when broker-dealers can execute cash and derivative transactions proximately they can increase their returns by serving a larger proportion of investors who hold diverse portfolios thereby helping investors to economize on transactions costs. The model predicts that transactions involving a cash and derivative will be effected through an integrated system. The second essay, "Stock Index Futures Trading and Stock Market Volatility," reviews theoretical models and empirical evidence on the relationships between the level of futures trading and volatility. An empirical investigation is conducted by examining the relationship between the daily trading value of the S&P 500 stock index futures contract and the traded value of New York Stock Exchange stocks and considers whether there is higher price volatility in the stock markets when the level of trading in the futures markets is high relative to trading in the cash market. No evidence, theoretical or empirical, is found to support the notion that futures trading leads to greater volatility in the underlying cash market. The third essay, "Liquidation and Delivery Under Conditions of Manipulation models how strategic traders would respond to manipulation given an option to liquidate or deliver on the contract. A perfect Bayesian equilibrium concept is used in which traders must decide whether to liquidate or deliver given the realization of the first period equilibrium futures price. If detected by floor brokers who competitively bid prices to their expected value, the manipulator will cause prices to move against him, raising the equilibrium price when he puts in orders to buy and lowering the price when he seeks to selL Revelation of manipulation through prices also alters the behavior of other traders. An analysis of reactions in a simplified extensive form game indicates that detection of manipulation allows other market participants to stategically adjust their plans regarding liquidation and avoid incurring losses to the manipulator. / Ph. D.