THE LIBOR RATE AND THE FINANCIAL CRISIS: HAS THE LIBOR RATE BEEN MANIPULATED? Lyon, 26 Feb. 2010...
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Transcript of THE LIBOR RATE AND THE FINANCIAL CRISIS: HAS THE LIBOR RATE BEEN MANIPULATED? Lyon, 26 Feb. 2010...
THE LIBOR RATE AND THE FINANCIAL CRISIS: THE LIBOR RATE AND THE FINANCIAL CRISIS: HAS THE LIBOR RATE BEEN MANIPULATED?HAS THE LIBOR RATE BEEN MANIPULATED?
Lyon, 26 Feb. 2010Lyon, 26 Feb. 2010Research Seminar in Economics and finance Research Seminar in Economics and finance
Alexandre Hartheiser Alexandre Hartheiser Philippe SpieserPhilippe Spieser
ESCP EUROPEESCP EUROPE
I. Presentation of the paper(work in progress…)
The Libor, which is a rate of high importance in the financial world, was highly discussed during the climax of the crisis.
The paper is an attempt to answer to academic and practitioners who suspected the Libor being “manipulated”.
This contribution is more an inquiry, based an different techniques and which deserves further investigations
Consequently, the “methodology” uses different approaches: distortions with financial theory, econometric model, factorial analysis.
I I. Literature
Very few contribution on that topics
LIBOR Manipulation :
Rosa Abrantes-Metz, M.Kraten, Albert D. Metz, G.Seow LECG, LLC; Leonard N. Stern School of Business - Department of EconomicsSuffolk University - Sawyer School of ManagementMoody's Investors ServiceUniversity of Connecticut - School of Business Working Paper Series, August 2008 2008
Poskitt,R.: The stigma hypothesis: strategic quote behavior in the Libor Fixing, Journal of International Financial Markets, Institutions and Money, December 2008, 399-412.
Gyntelberg, J. and Wooldridge, P. Interbank rate fixing during the recent turmoil. BIS Quaterly Review, March 2008
III. Suspicion of manipulation The Libor is regarded as undervalued referring to the cost of risk during
the first 3 months of 2008 : Banks would have provided inexact quotations regarding their true financing cost.
Numerous specific clues :
Libor evolves under the risk free rate of the Federal Reserve (10 bp below during the first week of April).Yet, a bank should not pay a rate above Libor to borrow from the FED.
Deposit rates €/$ at FED are above the Libor, a situation which is abnormal and cannot last.
Libor USD 3 months increases by 20 bp after the launching of an inquiry from the BBA (on the 16th April 2008) regarding the “fairness” of the Libor determination .
We are led to distinguish 4 subperiods in the whole period between 1/2005 and 11/2008
I I I. Libor during the crisis: a strange behavior compared with other
referencies The spread between Libor and other close reference rates (OIS, TB,
Fed Funds, Repo…) has widen dramatically since mid-2007, a phenomenon can be easily explained by the “liquidity gap” :
Banks refuse to lend to each other.
Spread Libor 3M contre Swap OIS 3M
0,00
0,50
1,00
1,50
2,00
20-Dec-04 8-Jul-05 24-Jan-06 12-Aug-06 28-Feb-07 16-Sep-07 3-Apr-08
1
2
3
4
5
6
20/1
2/04
20/0
2/05
20/0
4/05
20/0
6/05
20/0
8/05
20/1
0/05
20/1
2/05
20/0
2/06
20/0
4/06
20/0
6/06
20/0
8/06
20/1
0/06
20/1
2/06
20/0
2/07
20/0
4/07
20/0
6/07
20/0
8/07
20/1
0/07
20/1
2/07
20/0
2/08
20/0
4/08
20/0
6/08
20/0
8/08
%
Libor USD 3M
OIS 3M
I V. Why a fake fixing ?
Libor quotes being public, any quote showing a high level of Libor might be interpreted as an urgent need for financing (the bank will borrow at a high cost).
The crisis had made most banks in position of borrowing and any high fixing would made its liquidity cost more expensive.
The trouble is that the fixed libor hasn’t been actually practiced in the market (banks used to add a spread during this period).
Consequently, banks have searched to push down the rate to borrow, but with a upwards bias to lend.
As a result, the effective rate was 20 to 30bp above were it should have been between January to April 2008.
V. A first measure of distorsion : Libor and the covered interest change parity (with GBP and EUR)
Libor USD 3M = (1 + Libor GBP 3 months) * Fwd rate 3M USD-GBP – 1
Spot GBP-USD
A large deviation vis-à-vis the law is to be observedDaily Spread: Fixing Libor USD 3M – Theoretical Libor Daily Spread: Fixing Libor USD 3M – Theoretical Libor
estimated by Interest Rate Covered Parity with EURO estimated by Interest Rate Covered Parity with GBP
-3
-2
-1
0
1
2
3
04/04
/06
04/06
/06
04/08
/06
04/10
/06
04/12
/06
04/02
/07
04/04
/07
04/06
/07
04/08
/07
04/10
/07
04/12
/07
04/02
/08
04/04
/08
04/06
/08
04/08
/08
%
-3
-2
-1
0
1
2
3%
VI. Towards a reconstructed Libor
We compared first Libor with rates that were historically close to it : T Bills, Fed Funds
We then built an econometric model by adding a measure of risk
VI a. Libor and Treasury Bills An strong historical correlation till the crisis which actually began at the mid
August 2007 The spread might be regarded as an estimator for the crisis intensity. Stress factors clearly identified by obeserving the peaks and shocks of the
spreads: AIG / BNP Paribas ; BBA’s inquiry ; Lehman bankruptcy…
0
0,5
1
1,5
2
2,5
3
3,5
4
4,5
5 Spread Libor 3M - Treasury Bill 3M
VI b. Libor and Effective Fed Fund Rates
A good measure for deposit rate is given by the effective fed funds rates. Again we can observe a clear incoherence with the Libor’s behavior after August 2007 and especially during the three first months of 2008 (since Libor went below it).
-0,5
0
0,5
1
1,5
2
2,5
3
3,5
4
4,5Spread Libor USD 1M - Effective Funds Effective rate
VI c. Estimation of a theoretical Libor: Econometric model
The model is : Li = β1 * T-Bill + β2 * Risk factor
We tested all possible models : T bills, but also EFFR and Repo rates As a Risk factor, two variables retained : average of CDS Spreads at day i -1
and average of the volatility of Put ATM on the panel at day i -1
All rates were very good regression variables (see results)
The coefficients βi are nevertheless statistically unstable after August 2007
The regression coefficient become even negative during the last periods under review, which is economically absurd unless ther is a suspicion of mispricing
VI c. Estimation of a theoretical Libor (cont.) :
•As a result of a model backtesting , we observe huge spreads with the official or real Libor;•Those spreads are significantly important and Libor fluctuates in unexpected proportions. The critics against a too low rate since beginning 2008 seem justified. •But it is also obvious that according to the model, the Libor could have been even too high since March 2007 till January 2008, i.e. a time period which spreads before the subprime crisis burst out and the beginning of the peak itself. • We also notice the effects of BBA announcement (16 April) and the Lehman’s bankruptcy
0
1
2
3
4
5
6
7
8Libor 3M USD
Theorical Libor 3M USD from model with CDS
0
1
2
3
4
5
6
7
8
9Libor 3M USD
Theorical Libor 3M USD from model with Vol put ATM
VII. Going further : study of individual
quotations We are convinced that econometric measures are not
sufficient due for example to a difficult comparison of rates at different maturities : Non linearity of the risk in time Supplementary liquidity risk premium for CDS contracts.
We try to identify a “cartel”, if any …
The study of individual quotations is hence necessary.
VII a. Inquiry of the individual quotations Analysis of the decision rate table
The global decision rate (i.e. the number of times they actually participate to the panel) drops from the « calm » period (86%) to the crisis periods ( between 68% after April 2008 and 77% during period 2)
0
0,01
0,02
0,03
0,04
0,05
0,06
0,07
0,08
0,09
0,1
0
0,05
0,1
0,15
0,2
0,25
0,3
0,35
0,4
0,45%
Variation coef. on Libor quotes Absolute variations on Libor fixing
VII b. Inquiry of the individual quotations
Through the correlation analysis between the path of the spreads of each bank‘s CDS, which gives information on its default risk and the evolution of its quotation proposal, we try to detect the illogical behavior of certain banks and a possible cartel ( at least 5 associated banks)
-1,1
-0,6
-0,1
0,4
0,9
%Spread Max [Libor USD 3M - individual quote]
Spread Min [Libor USD 3M - individual quote]
VII b. Inquiry of the individual quotations (cont.)
Practically we analyzed the correlation between: - The spread of the previous day less the average of the CDS
the previous day;- the spread i.e. the day fixing less the proposed quotation
for each bank. A bank seeking to send a fake signal will show logically a negative
correlation between those two measures. BoA, RBS, HBOS, Citi and UBS did not submit logical quotes during the
crisis (period preceding the BBA warning and the post Lehman time).
Spreads : Cotation individuelle - Fixing
-1,1
-0,6
-0,1
0,4
0,9Citi BOA
Bank of tokyo Barclays
Credit Suisse Deutsch Bank
HBOS HSBC
JPM Lloyds TSB
Norinchukin rabobank
RBC RBS
UBS WEST LB
Spreads de CDS Senior 5 ans
0,00
100,00
200,00
300,00
400,00
500,00
600,00
700,00
Citi
BOA
Bank of tokyo
Barclays
Credit Suisse
Deutsch Bank
HBOS
HSBC
JP MORGAN CHASE
Lloyds TSB
Norinchukin Bank
rabobank
royal bank of canada
royal bank of scotland
UBS
WEST LB
VII b. Inquiry of the individual quotations (correlation matrix)
Spread Daily
Fixing - Individual Quotation
Period 2 Spread : CDS - Average of CDS
Citi BOABank of Tokyo Barclays
Credit Suisse
Deutsch Bk HBOS HSBC
JP MORG Lloyds RBS UBS HBOS
Norinchukin
WEST LB
Citi -0,22 0,00 0,02 0,22 -0,19 -0,02 0,21 -0,05 0,14 0,11 -0,14 -0,18 0,14 -0,19 -0,15
BOA 0,10 -0,18 0,05 -0,01 0,20 0,10 -0,14 -0,12 -0,08 -0,06 0,15 0,24 -0,14 0,25 0,01
Bk Tokyo -0,36 0,27 0,17 0,12 -0,34 -0,07 -0,11 0,15 0,37 0,16 -0,25 -0,39 0,33 -0,21 0,03
Barclays -0,02 0,12 0,34 -0,02 -0,15 -0,25 -0,23 0,18 0,06 -0,13 -0,06 -0,07 0,02 0,11 0,20
CS 0,26 -0,20 0,28 -0,25 0,06 -0,30 -0,09 -0,17 -0,26 -0,20 0,13 0,34 -0,29 0,39 0,21
Deutsch -0,14 -0,21 0,01 0,19 0,13 0,08 0,24 -0,22 0,01 -0,14 0,17 0,10 -0,10 0,02 -0,06
HBOS 0,42 -0,31 0,08 -0,41 0,29 -0,31 0,17 -0,35 -0,49 -0,16 0,08 0,38 -0,36 0,39 0,06
HSBC 0,10 0,04 0,11 -0,09 0,03 -0,07 -0,04 0,11 -0,09 -0,11 0,09 0,05 -0,08 0,10 -0,03
JPM 0,04 0,00 -0,09 -0,05 0,05 -0,15 0,00 0,07 -0,03 -0,08 0,07 0,02 -0,04 -0,09 0,19
Lloyds 0,02 -0,14 -0,30 0,10 0,15 0,33 0,02 -0,14 -0,07 0,04 0,07 0,16 -0,05 -0,05 0,02
RBS -0,24 0,09 -0,31 0,03 -0,10 0,25 -0,02 0,04 0,28 0,46 -0,30 -0,34 0,35 -0,36 -0,06
UBS -0,09 0,15 0,39 -0,03 -0,38 -0,09 -0,07 0,17 0,05 -0,16 -0,05 -0,16 0,00 0,16 0,13
HBOS 0,48 -0,11 0,03 -0,48 0,25 -0,28 -0,22 -0,07 -0,34 -0,20 0,05 0,34 -0,29 0,38 0,31
Norin. -0,26 0,19 -0,33 0,28 -0,19 0,37 0,18 0,05 0,29 0,18 -0,07 -0,24 0,25 -0,49 -0,20
WEST -0,15 0,25 -0,09 0,23 -0,12 0,18 -0,06 0,22 0,17 -0,02 0,04 -0,14 0,14 -0,27 -0,04
VII. c. Analysis of the individual quotation The detection of cooperative strategies might be done through
“discriminant analysis “.
Cluster Analysis is a multivariate analysis technique that seeks to organize information about variables so that relatively homogenous groups, or "clusters," can be formed. The clusters formed with this family of methods should be highly internally homogenous and highly externally heterogeneous.
As an input, we used the matrix of proposed rates by the different banks at the different periods (see the paper)
VII. c. Analysis of the individual quotation
As an output, we get through dendrograms a representation of clusters helping us to detect the similar strategies of rates proposals
PERIOD 1
D e n d r o g r a m
-0 ,043622785
0 ,156377215
0 ,356377215
0 ,556377215
0 ,756377215
0 ,956377215
Sim
ilarity
VII. c. Analysis of the individual quotation:
Example of group for period 2which allows us to find the same banks as those detected by the « individual
quotations » analysis For Period 3 (17 April 2008 to 23 September 2008) the clustering gives three classes :
Group 1 Group 2 Group 3
Citigroup
Bank of Tokyo
JPMorgan Chase
HBOS
BOA
Lloyds TSB
RBOS
West LB
Rabobank
Deutsche Bank
Credit Suisse
Barclays
Royal Bank of Canada
HSBC
Norinchukia Bank
UBS
Conclusion According to observers, Libor has been abnormally low during defined periods (for
example, the three first months of 2008.) Some banks seem to have proposed illogical quotations and the paper was designed to find an empirical proof for that with different means.
The Libor was not only low, it showed also a very low variance, incompatible with real economic conditions
This phenomenon lessened if not ceased on April 16, following the inquiry launched by BBA - which concluded in June by a case dismissal .
During the 11 months before the subprime crisis, the Libor fixing arouse a strong consensus among observers. During the first months of 2007, it should have lowered in parallel with TB and CDS, although it remained on the same trend.
Limitations of the study : the use of other short term references is not necessarily a solution because :
They are not used for the same purposes and in the same way ; The Icap rate (a reference designed by Icap international as a possible substitute ) is
merely a copy of the Libor Factorial (discriminant) analysis is useful but should be clearly interpreted in terms of
metrics/distance and results. This paper has lost a part of its accuracy since the Libor has recovered an apparently
coherent level with market parameters and gaines confidence by investors.