The Effect of the Eurocurrency Markets on the Arbitrage Process

Abstract

The purpose of this chapter is to examine the effect of the Eurocurrency markets on monetary independence with specific reference to arbitrage and capital flows. Through an analysis of the workings of the market and interest rate determination therein, we shall endeavour to assess the effect of the Eurocurrency market on arbitrage efficiency; the new channels it has introduced and the extent to which it has resulted in greater integration of international capital markets. However, greater efficiency of arbitrage need not entail greater interdependence as we saw in chapter 2. A major issue is whether floating exchange rates, and in particular the forward exchange rate, will adjust to restore interest parity. The pressures on the interest rate of a small country, arising from a change in the interest rate of, for example, a large country such as the US, are thus absorbed.