This paper uses the Keynesian Beauty Contest as a theoretical framework to analyse the LIBOR fixing mechanism. The ‘true’ money market rate can be seen as a fundamental value, or focal point, towards which the LIBOR should aim. By treating the LIBOR as the outcome of a particular and unusual kind of p-beauty contest game, where the behaviour of the players (LIBOR banks) are guided by higher order beliefs, a process is created whereby they are not solely dependent on their own incentives and constraints. Instead, potential deception can be seen as being generated endogenously though the fixing process itself. Simply the anticipation of possible attempts by others to submit deceptive LIBOR quotes will prompt neutral players to play ‘dishonestly’. As a result, it is demonstrated that deviations of the LIBOR from what could be regarded as its ‘fundamental value’ (the underlying money market), are not temporary, but long-lasting and systematic.
|Name||Research on money and finance discussion paper|
|Publisher||Department of Economics, SOAS, University of London|