What Are Reference Rates For?

Divya Kirti

No 2017/013, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; reference rate; risk tolerance; Reference rates; interest rate risk; floating rate; interest-rate derivative; total utility; Hedging; Interbank rates; Credit risk; Loans; Credit; Europe; Global (search for similar items in EconPapers)
Pages: 45
Date: 2017-01-27
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Journal Article: What are reference rates for? (2022)
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