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Recently Monetary Authority of Singapore (MAS) raps banks in rate-rigging. This is nothing new, LIBOR was also manupulated before, by some "major" banks.

however, before the censorship, did any "minor" bank declare that the interest rate from LIBOR is distorted?

seems modellers always assume the market is right, so models, or parameters used in the model are always first calibrated according to the market, then used to price products.

so even there is a problem, people will try to find some work-around. for example if the term structure leds to a negative future rate, the curve is still accepted.

is there some mechanism to detect such abnormality and flag "market is wrong" ?

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up vote 1 down vote accepted

Nobody assumes the market is right. The issue with Libor was that nobody could do much about it. Well, not 100% correct, you had the following 3 choices:

  • Participate in the scheme and benefit (monetarily)
  • Be on the receiving end and despite you knowing the rate is not what it should be you have no choice, you gotta borrow/lend your funds at the end of the day no matter what.
  • You complain to regulators, the same regulators whose salaries are paid to a large degree by the very same bank conglomerates that set Libor every day.

The choice was/is yours...

So, even if you know that market prices are distorted what are you gonna do about it. Assume for a second that you know that the skew of most index options should be much more pronounced. You basically believe the market has it wrong and does not price risk appropriately. If you want to trade on your believes you can of course do so, however, whether anyone else trades with you is another question, entirely. And if the market does not converge to your own estimate of where you see it is fairly valued at then you will not even benefit from your "correct model".

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