I guess FCRP between say Spain and Germany doesn’t make sense, since there is exchange rate! But since both have euro for currency, wouldn’t want buy Spanish government bonds and get 5+% return rather than 3+ return in Germany? You could say the risk is different but we are talking about government bonds and short term too!
You could buy Greek and get like 15%, cause they’re government bonds and its only short term.
I wouldn’t because Greece has serious short-term problems, but Spain? Ok, ignore Spain, how about France, there is still a difference in rates, and I don’t think the French government is going belly up in a year!
I was being sarcastic with my last post. But seriously, could you arbitrage it? Could you buy Euro’s today, invest them in France gov bonds, and enter into forward to sell euros a year from now and profit? Or are the forwards on euro’s priced using a basket of gov returns or just the highest legitimate gov return (so take out PIIGs)? I don’t know any of this, but you could go grab some real price data and take a crack at it.
I’m assuming there is an implicit risk premium used when pricing forwards on euros because any member nation could do something stupid and cause the euro to tank.
Does anyone know of a link that addresses this issue? That is why are short-term interest rates are different within Euro land?
http://edoc.hu-berlin.de/series/sfb-373-papers/2003-40/PDF/40.pdf
This is older, it talks about the convergence of interest rates within euroland.
Thanks 1logic…I went through it quickly, it’s very long and it talks about the convergence of interest rates and why it’s not happening as expected, but I didn’t see how arbitrage is not possible.