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The role of the reference rate in an interbank market with imperfect information

Ichiro Muto

Global Finance Journal, 2017, vol. 34, issue C, 16-31

Abstract: This study investigates the potential role of the reference rate in an interbank market where individual banks cannot fully identify the nature of underlying shocks affecting their interbank transactions. We find that the reference rate does not always mitigate the market distortion arising from imperfect information. When the number of sample transactions is smaller than a certain threshold, the reference rate magnifies the distortion even if the reference rate is not affected by any reporting noise. The threshold depends on the relative size of aggregate and idiosyncratic shocks. Noise in the reported interest rates, which is potentially increased by banks' manipulations, distorts individual banks' inferences about the underlying shocks, and thereby raises the threshold. When noise is highly correlated among multiple sample transactions, perhaps owing to collusive manipulations, it is possible that increasing the number of sample transactions may never mitigate the market distortion.

Keywords: Interbank market; Reference rate; Imperfect information; Financial stability (search for similar items in EconPapers)
JEL-codes: E43 E44 G14 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:glofin:v:34:y:2017:i:c:p:16-31