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 in:Journal of banking & finance 2022-11, Vol.144, p.106635, Article 106635
Main Author: Kirti, Divya
Format: Article
Language:English
Subjects:
IBORs
Interest-rate risk
Reference rates
RFRs
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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