Reforming LIBOR and Other Financial-Market Benchmarks

36 Pages Posted: 9 Oct 2014

See all articles by Darrell Duffie

Darrell Duffie

Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER); Canadian Derivatives Institute

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 19, 2014

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; (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.

Keywords: Benchmarks, LIBOR, manipulation, reference rate reform

JEL Classification: G12, G14, G18, G21, G23

Suggested Citation

Duffie, James Darrell and Stein, Jeremy C., Reforming LIBOR and Other Financial-Market Benchmarks (September 19, 2014). Stanford University Graduate School of Business Research Paper No. 14-41, Available at SSRN: https://ssrn.com/abstract=2506792 or http://dx.doi.org/10.2139/ssrn.2506792

James Darrell Duffie (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Knight Management Center
Stanford, CA 94305-7298
United States
650-723-1976 (Phone)
650-725-8916 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Canadian Derivatives Institute ( email )

3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7
Canada

Jeremy C. Stein

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-496-6455 (Phone)
617-496-7352 (Fax)

HOME PAGE: http://post.economics.harvard.edu/faculty/stein/stein.html

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
334
Abstract Views
1,996
Rank
164,148
PlumX Metrics