Cheap Talk and Strategic Rounding in Libor Submissions

Interbanking rates were, until recently, based on judgmental estimates of borrowing costs. We interpret this as a cheap talk game that allowed banks to communicate non verifiable information about their opportunity cost to potential counterparties. Under normal market conditions there is a welfare maximizing equilibrium where banks truthfully disclose their borrowing cost, but, in times of financial stress, only "coarse" equilibria survive. We take this prediction to the data and show that banks round more frequently if the risk of the bank increases. Rounding is also more frequent for the more liquid short term rates and certain benchmark maturities.

oligopoly and other forms of market imperfection; asymmetric and private information; mechanism design; search; learning; information and knowledge; communication; belief; unawareness; financial institutions and services

Cheap Talk and Strategic Rounding in Libor Submissions Articles