What are reference rates for?

Reference rates like LIBOR were designed to reflect banks’ full cost of funds, including credit premia. With publication of LIBOR expected to cease soon, regulators have recommended a shift to risk-free reference rates. To study the implications of this shift, this paper develops a tractable model o...

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Bibliographic Details
Published inJournal of banking & finance Vol. 144; p. 106635
Main Author Kirti, Divya
Format Journal Article
LanguageEnglish
Published Elsevier B.V 01.11.2022
Subjects
IBORs
Interest-rate risk
Reference rates
RFRs
Interest-rate risk
RFRs
IBORs
G21
G32
Reference rates
G18
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Summary:Reference rates like LIBOR were designed to reflect banks’ full cost of funds, including credit premia. With publication of LIBOR expected to cease soon, regulators have recommended a shift to risk-free reference rates. To study the implications of this shift, this paper develops a tractable model of bank lending and hedging in which the design of reference rates shapes the allocation of risk in equilibrium. Reference rates that capture credit risk, but are sufficiently free from manipulation, could improve welfare relative to risk-free reference rates. It remains an open question whether such reference rates can be constructed.
ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2022.106635