"Revision of the SDR: an external consequence of Europe's monetary union."

In this paper 1 consider a revision of the IMF's Special Drawing Rights (SDR) that may result from the adoption of the' European Currency Unit (ECU) by the European community in their program of Monetary Union. I develop data representing the monthly average exchange value for this new basket I call the SDR(ecu). This data is compared to the actual SDR series for the period January 1981 through December 1990. While these two baskets maintain essentially similar values over the period in question, the percentage rate of change in the SDR(ecu) is found to have a significantly smaller volatility than the SDR (as found by an Analysis of Variance test) . Using Sharpe's Index Model (1970) (a modified version of the capital asset pricing model) the reduced exchange rate risk is decomposed into components of "systematic" and "non-systematic" risk. The result I find suggest that although the overall exchange rate risk is small in the SDR(ecu), this risk is much more composed of the non-diversifiable "systematic" risk, than is the SDR. This leads me to recommend that a revision of the SDR to my SDR(ecu) would be an improvement over the existing arrangements. Second, the adoption of a coordinated effort among the G-3 (Dollar, Yen and ECU) monetary authorities, such as an exchange rate mechanism, would help manage the relative increase in "systematic" exchange risk. These recommendations would enhance the position of both the SDR and ECU as international reserve currencies.