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Research Division
Federal Reserve Bank of St. Louis
Working Paper Series
 The Effect of Underreporting on LIBOR Rates
Andrea MonticiniandDaniel L. Thornton
Working Paper 2013-008Ahttp://research.stlouisfed.org/wp/2013/2013-008.pdf February
FEDERAL RESERVE BANK OF ST. LOUISResearch DivisionP.O. Box 442St. Louis, MO 63166
 ______________________________________________________________________________________  The views expressed are those of the individual authors and do not necessarily reflect official positions othe Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors.Federal Reserve Bank of St. Louis Working Papers are preliminary materials circulated to stimulatediscussion and critical comment. References in publications to Federal Reserve Bank of St. Louis WorkingPapers (other than an acknowledgment that the writer has had access to unpublished material) should becleared with the author or authors.
 The Effect of Underreporting on LIBOR Rates
Andrea Monticini and Daniel L. Thornton
Catholic University, Milan ItalyandFederal Reserve Bank of St. Louis, St. Louis, Missouri USAFebruary 4, 2013
 On May 29, 2008, the
Wall Street Journal
reported that several largeinternational banks were reporting unjustifiably low LIBOR rates.Sincethen two large banks, Barclays and UBS, have paid significant fines formanipulating their LIBOR rates, and additional banks are expected to befined. This paper investigates whether the underreporting of LIBOR ratesby some banks significantly affected the reported LIBOR rate by testingwhether there was a significant change in the relationship between theLIBOR rate and another rate that reflects the default risk of banks. Keywords: LIBOR rate; default risk; structural breaks JEL Codes: G10, E43, E44 The views expressed are those of the authors and do not necessarily represent the views of theFederal Reserve System, the Board of Governors, or the regional Federal Reserve Banks. We thankRosa Abrantes-Metz, Angelo Baglioni, Ettore Croci, and David VanHoose for useful suggestions.
 LIBOR stands for “London interbank offered rate.” LIBOR rates were first published by the BritishBankers’ Association in 1986. Currently LIBOR rates are calculated by Thomson Reuters for tencurrencies with 15 maturities ranging from overnight to 12 months. LIBOR rates play an importantrole in financial markets. Exchanges such as LIFFE and Chicago Mercantile Exchange tradederivatives based on the LIBOR. The British Bankers’ Association estimates that financial swapsworth £225 trillion and loans totaling £6.4tn are indexed to LIBOR. Consequently, understatementof LIBOR rates can generate sizable wealth transfers from lenders to borrowers.
LIBOR rates are not based on transactions data but rather are calculated from the responseso
contributing banks to the following question: “
At what rate could you borrow funds, were you todo so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11am?
” The banks’ responses are submitted between 11:00 a.m. and 11:10 a.m.
and LIBOR rates arereleased at noon
A LIBOR rate scandal erupted on May 29, 2008, when the
Wall Street Journal
) reported a marked divergence between the LIBOR rate and the
’s calculation of the ratein the default insurance market. Subsequently, two large banks, Barclays and UBS, have paidsignificant fines for underreporting their LIBOR rates; other banks are expected to be fined. Thisessay investigates whether the apparent fraud by some banks significantly affected the reportedLIBOR rates.Banks have an incentive to understate their LIBOR rates because LIBOR is thought toreflect the default risk associated with interbank lending.
A bank that wants to appear morefinancially sound than it is has an incentive to underreport its LIBOR rates. Another reason tomanipulate the LIBOR is to alter derivative payments (e.g., on Interest Rate Swap contracts). Theunderreporting by a few banks need not have a significant effect on reported LIBOR rates becauseeach published rate is an average of the submitted rates after the highest and the lowest 25 per centof the rates have been deleted. This paper investigates whether underreporting of LIBOR rates by
1 See Thornton (2009).

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