Friday, May 30, 2008

Study Casts Doubt on Key Rate -


Suppose you have two measures of something. One that is market driven (observable prices) whereas the other is based off reported data. Usually the two move together. However, when they diverge, someone must ask why and which is more correct.

That is essentially what the WSJ did in the following article. They look at LIBOR and teh credit spread to gauge the level of uncertainity in the market. Sure enough, the two usually move together, but not always.

Study Casts Doubt on Key Rate -
"...beginning in late January, as fears grew about possible bank failures, the two measures began to diverge, with reported Libor rates failing to reflect rising default-insurance costs, the Journal analysis shows. The gap between the two measures was wider for Citigroup, Germany's WestLB, the United Kingdom's HBOS, J.P. Morgan Chase & Co. and Switzerland's UBS than for the other 11 banks. One possible explanation for the gap is that banks understated their borrowing rates."
Much of the paper is based on the fact that LIBOR is based BORROWING rates as reported by banks. This method of LIBOR calculation is not what I thought was done, so I learned somethig here. I always thought this was calculated by the rate banks were willing to lend at not what they were borrowing at. The two could have different numbers if the banks have an incentive to report lower rates for borrowing to assure the market their financial soundness.

1 comment:

Anonymous said...

What do you mean by a lending rate? Wouldn't a bank lend at different rates depending on whom they're lending to? Or do you mean that each of the 16 banks report 15 different rates every day depending on whom they'd lend to and the LIBOR is calculated off that?