Collusive Benchmark Rates Fixing

Abstract

Benchmark rates, such as Libor and Euribor, have been proven vulnerable to manipulation. We analyze benchmark rate collusion, which is challenging due to varying and opposing trading interests of the subset of market participants that determine the rates. Our theory is based on two mechanisms. We define front-running as information sharing that allows cartel members to optimally adjust their portfolios ahead of the market. To support the joint-profit maximizing rate, designated traders engage in costly manipulation of their submissions. We find that observed episodic recourse to independent quoting is part of a feasible continuous collusion equilibrium and that all panel members would want to participate in the scheme. Our model suggests that high rate volatility may be indicative of collusion. Further protocol reforms to broaden the class of transactions eligible for submission and to average over fewer middle quotes can unintentionally facilitate collusion.

Keywords: benchmark rate, Libor, Euribor, IRD, banking, cartel

JEL Classification: E43, G14, G21, K21, L41