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Reforming LIBOR and Other Financial-Market Benchmarks

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  • Duffie, Darrell

    (Stanford University)

  • Stein, Jeremy C.

    (Harvard University)

Abstract

We outline key steps necessary to reform the London Interbank Offered Rate (LIBOR) so as to improve its robustness to manipulation. We first discuss the role of financial benchmarks such as LIBOR in promoting over-the-counter market efficiency by improving transparency. We then describe how to mitigate LIBOR manipulation incentives by: (i) widening the types of transactions used to fix LIBOR; and (ii) encouraging a transition of "rates trading" applications of LIBOR derivatives to alternative reference rates that are in principle more suitable for this purpose because they do not include the bank-credit-spread component inherent in LIBOR. The current exceptional depth and liquidity of LIBOR-based markets are self-fulfilling sources of dominance for LIBOR as the reference rate of choice among rates traders. This liquidity agglomeration around LIBOR is probably accidental and inefficient, and creates an incentive to manipulate LIBOR. A transition of rates trading to alternative reference rates, however, may be difficult to arrange without official-sector involvement.

Suggested Citation

  • Duffie, Darrell & Stein, Jeremy C., 2014. "Reforming LIBOR and Other Financial-Market Benchmarks," Research Papers 3170, Stanford University, Graduate School of Business.
    • Handle: RePEc:ecl:stabus:3170
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    File URL: http://www.gsb.stanford.edu/faculty-research/working-papers/reforming-libor-other-financial-market-benchmarks
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    Cited by:

    1. Dániel Horváth & Eszter Makay, 2015. "Analysis methodology of interbank reference rates - International trends and the results of the first Hungarian annual statistical analysis for 2014," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 14(2), pages 62-88.
    2. Dubecq, Simon & Monfort, Alain & Renne, Jean-Paul & Roussellet, Guillaume, 2016. "Credit and liquidity in interbank rates: A quadratic approach," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 29-46.
    3. Darrell Duffie & Piotr Dworczak & Haoxiang Zhu, 2017. "Benchmarks in Search Markets," Journal of Finance, American Finance Association, vol. 72(5), pages 1983-2044, October.
    4. Chew Lian Chua & Sandy Suardi & Yuanchen Chang, 2017. "A re-examination of Libor rigging: a time-varying cointegration perspective," Quantitative Finance, Taylor & Francis Journals, vol. 17(9), pages 1367-1386, September.
    5. Thomas B. King & Kurt F. Lewis, 2014. "What Drives Bank Funding Spreads?," Working Paper Series WP-2014-23, Federal Reserve Bank of Chicago.
    6. repec:cbh:journl:v:14:y:2015:i:2:p:62-88 is not listed on IDEAS

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