What Are Reference Rates For?

Author/Editor:

Divya Kirti

Publication Date:

January 27, 2017

Electronic Access:

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

What is the precise role of reference rates? Why does it matter if LIBOR was manipulated? To address these questions, I analyze the use of reference rates in floating-rate loans and interestrate derivatives in the context of lending relationships. I develop a simple framework combining maturity transformation with three key frictions which generate meaningful funding risk and a rationale for risk management. Reference rates like LIBOR mitigate contractual incompleteness, facilitating management of funding risk. As bank funding costs move with bank credit risk, it makes sense for the reference rate to have a bank credit risk component. Manipulation can add noise, reducing the usefulness of reference rates for this purpose.

Series:

Working Paper No. 17/13

Subject:

English

Publication Date:

January 27, 2017

ISBN/ISSN:

9781475572315/1018-5941

Stock No:

WPIEA2017013

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

45

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