The International Financial Market and U.S. Interest Rates

Abstract

This paper examines the linkages between the Eurodollar and U.S. domestic financial markets. Despite the fact that these markets are characterized by rapid arbitrage of interest rate differentials, it is shown that using weekly data allows the isolation of significant fluctuations being transmitted between markets in both directions. That is, financial markets in the U.S. are affected significantly by foreign events and the Eurodollar market is significantly affected by events occurring in the U.S. Since a moderate amount of arbitrage occurs within a week's time and because there is no way to determine the source of any disturbances which affect both interest rates simultaneously, it is impossible to reach precise conclusions about the causes of historical variation in the rates. However, this paper provides evidence that at most forty percent of the variation in Eurodollar interest rates over the 1975-1978 period can be traced to domestic U.S. sources and that between about one-fifth and two-thirds of the variation in domestic rates can be traced to foreign sources.