The Eurodollar Market, Speculation, and Forward Exchange: Comment

Abstract

My comments will be directed primarily to some issues raised in Rich's theoretical and empirical analysis of the Eurodollar market. Drawing upon the pioneering work of Stein on short-term capital movements and the foreign exchange market [11]; Rich develops a mqdel of relations between the U.S., U.K., and Eurodollar money markets. Stein's basic model has already been the subject of considerable discussion [see 4 and 16], so I shall not go into its virtues and limitations here. I found the most interesting portion of Rich's paper to be his empirical results. This is not because they yielded surprising results, rather they generally supported a priori expectations and the results of other empirical studies. As the number of empirical studies in this broad area has grown, I have become somewhat more optimistic that some degree of general agreement over the rough magnitudes of a number of major parameters will emerge. One area in which this appears to be the case is the adjustment of the forward rate to changes in interest differentials. Using monthly data Rich found that over the period March, 1959, through December, 1964, the U.S.-U.K. forward rate tended to adjust by 70g0 of the change in U.S.-Eurodollar short-term interest-rate differential, and by 90So of the change in the U.S.-U.K. short-term interest-rate differential. These figures are consistent with the findings of other studies (see, for instance, [12] and [13]) that there is generally substantial, but less than complete, adjustment of forward rates to interest parity levels in response to changes in interest.rate differentials. This in turn would have important policy implications, for the efficacy of interest-rate and forward-intervention policies for balance-of payments purposes is a positive function of the elasticity of the covered arbitrage schedule (see Willett and Forte [ 18] ). At first glance it might appear that these findings are inconsistent with the direct econometric estimates of short-term capital mobility which have generally been much lower than was assumed by practioners and policy-makers. See, for instance, [1], [2], [7], and [11] . The interest-parity theory of forward rates, as usually exposited, assumes infinite capital mobility, i.e., a perfectly elastic, covered arbitrage schedule, such that capital would always flow as long as there was more than a mini-