LIBOR games: means, opportunities and incentives to deceive

This paper adopts a game-theoretical approach to analyse the LIBOR fixing mechanism. Several non-zero-sum LIBOR Games are modelled and then solved using a standard Bayes Nash solution. It is shown that collusive behaviour between LIBOR panel banks, or between banks and money market brokers, can lead to LIBOR fixings that deviate from what could be regarded as the true funding costs of the banks. However, collusive behaviour is not a prerequisite for such outcomes. Assuming players (banks) are rational and act out of self-interest, their endowments (such as LIBOR-indexed derivatives portfolios), or the stigma attached by signalling a relatively high funding cost, can provide LIBOR panel banks with sufficient incentives to submit quotes deviating from their actual funding cost. The trimming process, widely regarded as a hurdle for outright and single-handed manipulation, is shown to be overwhelmingly ineffective. Moreover, binding rules or constraints introduced in order to enhance transparency provide disappointing results. In sum, it is argued that the LIBOR games are characterized by an inherent structure whereby banks have the means, opportunity and incentive to submit deceptive quotes, leading to outcomes (LIBOR fixings) that deviate from the true average of the banks funding cost. Banks are given the chance to influence the LIBOR in a direction that is beneficial to them - stemming from the exclusive privilege to be able to play this game, in other words to participate in the LIBOR fixing process.