Eurocurrency Arbitrage

Abstract

It is well known that alternative views of the nature of the Eurocurrency market have important public policy implications. What is less widely acknowledged is that these alternative views depend importantly on assumptions about the efficiency of arbitrage between the domestic and Eurocurrency markets. For example, whether central banks’ deposits of their reserves in the Euromarket affect the size of the market depends on whether such placements are arbitraged back into domestic markets; and whether separate monetary intervention is needed to affect Eurodollar credit conditions depends on how readily domestic conditions are transmitted to the offshore markets. It follows that an understanding of the elasticity of arbitrage between the domestic and offshore markets, and among the different segments of the Eurocurrency market, might go a long way towards eliminating incorrect models of the Eurocurrency market, and therefore eliminating inappropriate policy prescriptions.

Larry Bjorkman was the author’s research assistant for this study.