LIBOR’s Poker: Interbank Borrowing Costs and Strategic Reporting
University of Hawaii
October 16, 2013
The recent LIBOR scandals have demonstrated that the panel banks did not report in good faith, leading some to question whether LIBOR was ever accurate. This article derives the equilibrium LIBOR reporting strategy and quantifies the LIBOR bias. It finds that the current trimming mechanism cannot prevent LIBOR rigging, although LIBOR bias goes down with the cross-sectional dispersion of the panel banks' borrowing costs. This explains why LIBOR earned wide adoption before the financial crisis. Additionally, signaling caps LIBOR. However, hiding individual banks' report to the market blocks signaling altogether. Finally, there exists a mechanism that induces truthful reporting.
Number of Pages in PDF File: 43
Keywords: LIBOR, manipulation, equilibrium strategy, auction theory, mechanism design
JEL Classification: G21, D44, D82
Date posted: August 28, 2012 ; Last revised: January 31, 2016