Stenfors, Alexis

264 Pages·2013·1.85 MB·English

Stenfors, Alexis (2013) Determining the LIBOR: a study of power and deception. PhD Thesis. SOAS, 
University of London 
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Determining the LIBOR:
A Study of Power and Deception

ALEXIS STENFORS

28 May 2013

Department of Economics
SOAS, University of London

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Declaration for PhD thesis

I have read and understood regulation 17.9 of the Regulations for
students of the School of Oriental and African Studies concerning
plagiarism. I undertake that all the material presented for examination is
my own work and has not been written for me, in whole or in part, by
any other person. I also undertake that any quotation or paraphrase from
the published or unpublished work of another person has been duly
acknowledged in the work which I present for examination.

Signed: Alexis Stenfors_____ Date:_28 May 2013______________

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ABSTRACT

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.

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ACKNOWLEDGMENTS

A number of people have helped me to realise this project, and I am grateful for all
the help and support I have been given during the years leading up to, as well as
during, my time at SOAS.

First of all to my father Professor Lars-Eric Stenfors: thank you for always having
been there as a source of inspiration. I wish you could have been here! I also owe
much gratitude to my fellow student Dr Ulf Söderström from my time at the
Stockholm School of Economics, and to my supervisor Professor Costas Lapavitsas
who showed belief in me during a difficult 2009, and of course during my whole
period as a PhD student.

A special thanks to all members of RMF (in particular Dr Juan Pablo Painceira, Dr
Annina Kaltenbrunner, Duncan Lindo and Dr Thomas Marois) for the stimulating
work on the Eurozone crisis and other issues in political economy, and to Professor
Stergios Skaperdas, Angus Macmillan and Nils Ahlstrand for help with the LIBOR
games. Gunnar Perdersen: many thanks for all our seemingly never-ending
discussions about benchmark fixings!

I would also like to express gratitude towards a number of traders and brokers - some
still very much involved in the LIBOR, EURIBOR, NIBOR, STIBOR, TIBOR and
CIBOR. You know who you are. Thanks for your honesty, and for sharing your time,
insight and thoughts.

To my daughters Rebecca and Magdalena: thank you so much - you have been
wonderful! And finally to Maria: your support ever since 1993 has been tremendous.
I cannot thank you enough.

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TABLE OF CONTENTS

ABSTRACT 3

ACKNOWLEDGMENTS 4

LIST OF FIGURES 9

LIST OF TABLES 10

LIST OF MATRICES 12

LIST OF ACRONYMS 13

CHAPTER 1: Introduction 16
1.1. Motivation, Purpose and Outline of the Dissertation 16

CHAPTER 2: The Anatomy of the LIBOR 24
2.1. Introduction 24
2.2. The First ‘Autopsy’ 25
2.2.1. LIBOR and the Monetary Transmission Mechanism 25
2.2.2. LIBOR and the Risk Premium 28
2.2.3. LIBOR and the Global Financial Crisis 32
2.2.4. LIBOR and Central Bank Policy 40
2.3. The Second ‘Autopsy’ 44
2.3.1. A Technical Critique 44
2.3.2. A Critique of the ‘Perception’ 49
2.3.3. Identifying the Fundamental Issues 52
2.3.4. A New Methodology 55

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CHAPTER 3: The Concept of Power 59
3.1. Power versus Voluntary Exchange 59
3.2. Power, Rationality and Self-interest 61
3.3. Power, Agency and Institutions 65
3.4. Power, State and Class 68
3.5. Power and Structures 71
3.6. A Multidimensional Approach to Power 75

CHAPTER 4: The Power of Central Banks 80
4.1. Introduction 80
4.2. Financial Stability and Power 82
4.3. Monetary Policy and Power 88
4.4. A Dynamic Power Relationship 91

CHAPTER 5: The LIBOR Illusion and the Structural 94
Power of Markets
5.1. Introduction 94
5.2. The History of the LIBOR 97
5.3. The Structural Power of the ‘Market’ 102
5.4. The LIBOR Illusion 106
5.4.1. Four Dimensions of the Illusion 106
5.4.2. The ‘Missing Link’ between Two Innovations 107
5.4.3. Beyond Information Asymmetry 109
5.4.4. Regulatory Arbitrage Re-emerges 111
5.4.5. The Transformation from ‘Real’ to ‘Fictitious’ Cash 114
5.5. Concluding Discussion 115

CHAPTER 6: LIBOR Games: Means, Opportunities and 119
Incentives to Deceive
6.1. LIBOR Manipulation? 119
6.2. Three Single-Period LIBOR Games 123
6.2.1. Assumptions and Rules of the Single-Period 123
LIBOR Games
6.2.2. Outcomes of the Single-Period LIBOR Games 128
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6.3. A LIBOR Game with Reputational Constraint and 132
Stigma Incentive
6.3.1. Assumptions and Rules of the LIBOR 132
Reputation/Stigma Game
6.3.2. Outcomes of the LIBOR Reputation/Stigma Game 135
6.4. Conclusions 140

CHAPTER 7: LIBOR as a Keynesian Beauty Contest: 144
A Process of Endogenous Deception
7.1. Introduction 144
7.2. The p-Beauty Contest Game: 146
Regarding the Money Market as the ‘Fundamental Value’
7.3. The LIBOR p-Beauty Contest Game 150
7.3.1. Rules of the game 150
7.3.2. Outcome: A Process towards ‘Endogenous Deception’ 153
7.4. Concluding Discussion 157

CHAPTER 8: LIBOR Club Power: A Case Study on the NIBOR 162
8.1. LIBOR Clubs 162
8.2. Notes on Data 168
8.3. Actor A: The NIBOR Club 169
8.3.1. The CIP Deviation as a Trigger Point 169
8.3.2. A Rule Change Secretly Instigated by the NIBOR Club 172
8.3.3. Testing the NIBOR Rule Change 174
8.3.4. Empirical Results 176
8.4. Actor B: Norges Bank 179
8.4.1. The Impact on the NOK Risk Premium 179
8.4.2. The Impact on the NOK Risk Premium Projections 185
8.5. Concluding Remarks 190

CHAPTER 9: Conclusions 193
9.1. Introduction 193
9.1. The Power of LIBOR Banks 194
9.2. LIBOR and the Power of Central Banks 195
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9.4. LIBOR as a Benchmark 203

APPENDIX 1: Definitions, Fixing Mechanisms and Club Structures 210

APPENDIX 2: The Endowment in LIBOR Games 222

APPENDIX 3: Probabilities and Expected LIBOR Outcomes 225

APPENDIX 4: Beliefs, Expected Payoffs and Expected LIBOR 229
Equilibria

APPENDIX 5: NIBOR Rule Change: Empirical Results 242

REFERENCES 248

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LIST OF FIGURES

Figure 2.1: 3M USD OIS; T-bill; LIBOR; Fed Eurodollar bid 29
2007 – 2010
Figure 2.2: 3M LIBOR-OIS Q1 2007 - Q2 2012 35
Figure 2.3: 1Y CRS Q1 2007 - Q2 2012 38
Figure 2.4: 3M LIBOR-OIS 2007 46
Figure 6.1: Time Line of Events (LIBOR Base Game) 123
Figure 6.2: Time Line of Events (LIBOR Collusion Game) 124
Figure 6.3: Time Line of Events (LIBOR Bribe Game) 125
Figure 6.4: Time Line of Events (LIBOR Game with Reputation/Stigma) 132
Figure 8.1: 3M Lib-Ois; Eur-Eon; CRS (USDEUR); CRS (USDNOK) 167
2007 - 2011
Figure 8.2: 3M NibOis; EibOis, LibOis; KliemOis 2007 – 2011 170
Figure 8.3: 3M NibOis; LibOis; 5Y CDS (NibLib) 2008 – 2011 174
Figure 8.4: 3M Money Market Risk Premia 2008 – 2011 183

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