The Manipulation Potential of Libor and Euribor

The London Interbank Offered Rate (Libor) and the Euro Interbank Offered Rate (Euribor) are two key market benchmark interest rates used in a plethora of financial contracts with notional amounts running into the hundreds of trillions of dollars. The integrity of the rate-setting process for these benchmarks has been under intense scrutiny ever since the first reports of attempts to manipulate these rates surfaced in 2007. In this paper, we analyze Libor and Euribor rate submissions by the individual panel banks and shed light on the underlying manipulation potential, by quantifying their effects on the final rate set (the "fixing"). We explicitly take into account the possibility of collusion between several market participants. Our setup allows us to quantify such effects for the actual rate-setting process that is in place at present, and compare it to several alternative rate-setting procedures. We find that such alternative rate fixings, particularly methodologies that eliminate outliers based on the median of submitted rates and the time-series of past submissions, could significantly reduce the effect of manipulation. Furthermore, we discuss the role of the sample size and the particular questions asked of the panel banks, which are different for Libor and Euribor, and examine the need for a transactions database to validate individual submissions