DP445 ECU Interest Rates and ECU Basket Adjustments: An Arbitrage Pricing Approach

Author(s): Martin Klein
Publication Date: September 1990
Keyword(s): Arbitrage, Currency Basket, Ecu, EMS, Interest Rates
JEL(s): 026, 313, 521
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=445

This paper considers arbitrage pricing of bonds and the determination of interest rates in the European Currency Unit (ecu) in situations of impending ecu basket adjustments. These adjustments disrupt the markets for private ecu assets with a lead of several months. The approach of the paper is based on the observation that the ecu is a derivative asset, so that in the absence of transaction costs prices of ecu-denominated assets should be determined by the prices of the existing member currency assets and the member currencies' exchange rates. Using the technical apparatus of arbitrage pricing theory it is shown how the fundamental arbitrage pricing relationships implied by the derivative character of the ecu have to be adjusted in order to be applicable during periods of ecu basket adjustments.