Determining the LIBOR : a study of power and deception

This dissertation uses an interdisciplinary approach to investigate the determination of the London Interbank Offered Rate (LIBOR). It is shown that the LIBOR is a fundamentally flawed benchmark stemming from the institutional characteristics of financial markets in general and the practices of banks in particular. As a consequence, the LIBOR is vulnerable to deception. It also gives rise to the misleading perception that it is the outcome of a market-determined process. Specifically, a game-theoretic approach is adopted to analyse the LIBOR fixing mechanism. Several non-zero-sum ‘LIBOR Games’ are modelled and solved using a Bayes Nash solution, demonstrating that the banks determining the LIBOR have the means, opportunities, and incentives to submit deceptive quotes, resulting in LIBOR values that deviate from the actual average bank funding cost. Particularly important in this context are LIBOR-indexed derivatives portfolios and the stigma attached to signalling a relatively high funding cost by banks. By deploying the framework of a Keynesian Beauty Contest it then shown that deviations of the LIBOR from what could be regarded as its fundamental value could be long-lasting and systematic.Deception is thus generated endogenously, i.e., though the fixing process itself. Further, a structural approach to the concept of power is developed within a political economy framework showing that the interests of the LIBOR banks have been served historically, through changes ranging from financial innovation to deregulation. LIBOR-determining banks can thus be conceived as ‘LIBOR Clubs’ with the structural power to promote their interests through the LIBOR fixing process. In the same vein, the LIBOR is a lens through which to examine significant features of the power relationship between the central bank and other banks. The power of the LIBOR-determining banks is illustrated through the empirical examination of a recent rule change impacting on the Norwegian NIBOR