The world's most important number is broken - review of reference interest rates

Abstract

This thesis studies the validity of unsecured interbank benchmark rates Euribor and Libor. In addition to the representativeness issues arising from the decline of unsecured interbank market activity, the reference rates have been subject to manipulation. I reviewed the manipulation scandal, and the academic studies related to it and contributed to the academic literature with my own empirical analysis. In the analysis, I studied the implied risk spread of individual banks' 12 month euro Libor submissions' co-integration relationship to maturity matched credit default swap rates (CDS) of the corresponding banks. I found evidence that during the years 2007-2009 the manipulation was more widespread than what was considered by the authorities. In addition, some banks continued (2009-) submitting rates that are not in line with their CDS rates. These findings speak for the necessity of ongoing reference rate reform. In addition, the methods presented in this thesis could be employed in the Libor quality moni-toring.