Manipulation in Money Markets

Abstract

Interest rate derivatives are among the most actively traded financial instruments in the main currency areas. With values of positions reacting immediately to the underlying index of daily interbank rates, manipulation has become an increasing challenge for the operational implementation of monetary policy. To address this issue, we study a microstructure model in which a commercial bank may have strategic recourse to central bank standing facilities. We characterise an equilibrium in which market rates will be manipulated with strictly positive probability. Our findings have an immediate bearing on recent developments in the Sterling and Euro money markets. Interest rate derivatives are among the most actively traded financial instruments in the main currency areas. With values of positions reacting immediately to the underlying index of daily interbank rates, manipulation has become an increasing challenge for the operational implementation of monetary policy. To address this issue, we study a microstructure model in which a commercial bank may have strategic recourse to central bank standing facilities. We characterise an equilibrium in which market rates will be manipulated with strictly positive probability. Our findings have an immediate bearing on recent developments in the Sterling and Euro money markets. Manipulation in Money MarketsJEL classification: D84, E52

Libor manipulation?

“…Finally, price indices are easy to explain, making them accessible to judges, attorneys and jurors. Ewerhart et al (2007) develop a microstructure model in which commercial banks with strategic recourse to central bank standing facilities may be expected to fix money market rates. Recent governmental efforts to develop screening devices are described in Abrantes-Metz and Froeb (2008).…”

Testing Information Diffusion in the Decentralized Unsecured Market for Euro Funds

“…4 We can also interpret valuation changes as strategic moves. Ewerhart et al (2007) proposed a model in which commercial banks may manipulate market rates, and in which interest rate derivatives have a key role since they induce traders to leverage their positions. They analyse this strategic behavior in a theoretical framework with a corridor and find that manipulators gain control of market rates by using standing facilities.…”

Optimal allotment policy in central bank open market operations1

“…The Appendix contains the proof of Proposition 4. Ewerhart et al (2007) document and model manipulation of the euro money market. In the formal analysis, a commercial bank finds it in its best interest to sporadically leverage its exposure to the interbank rate by contracting in the market for overnight index swaps.…”

“…In reality, the effect of a liquidity imbalance in the market should be smaller than this figure due to imperfect information about autonomous liquidity factors (cf. Ewerhart et al 2004). …”