The new system called 'Block 4' was being installed in missile batteries, The Jerusalem Post reported.
The paper said the new would improve accuracy in intercepting medium-range missiles such as Iran's "Shahab" and "Sejil," as well as Scud Ds held by Syria.
The Arrow-2 is Israel's upper tier missile defence system, complemented by the Iron Dome for short-range rockets and the David's Sling, which is under development and to be used against medium-range rockets and cruise missiles.
In the coming months, the Defence Ministry plans to hold its first interception test of the Arrow 3, a new higher-level system that will provide Israel with a number of chances to intercept incoming enemy missiles.
The US has given up to 80 per cent of the funding for the first-generation Arrow system.