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Today, I want to revisit the EONIA mystery. Why because when it first came to my attention last week, I hate to say it but I didn’t know much about it.

Screenshot 2017-12-10 12.22.06

I wanted to deep dive further into the shady, opaque world of interbank lending, that has been infamously tarnished by the LIBOR scandal that broke in 2012.

What also peaked my interest was the price transparency problem and subsequent benchmarks in search markets discussion in The Journal of Finance Vol.72, No.5 October 2017 issue, proposed by Mr. Darrell Duffie, Mr. Piotr Dworczak, and Mr. Haoxiang Zhu.

I will merely highlight their findings in Search Markets and avoid diving too deep, where in which I lose the day completely.

Okay so let’s wade into this one-step at a time, puram!

Here is a brief background on the said scandal mentioned above from the Council on Foreign Relation’s backgrounder James McBride.

Beginning in 2012, an international investigation into the London Interbank Offered Rate, or Libor, revealed a widespread plot by multiple banks—notably Deutsche Bank, Barclays, UBS, Rabobank, and the Royal Bank of Scotland—to manipulate these interest rates for profit starting as far back as 2003.

Okay, so in effect Libor is a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market, (e.g., the acronym, Libor). This benchmark is fixed and post the scandal, Britain’s primary financial regulator, the Financial Conduct Authority (FCA), has replaced the British Bankers’ Association (BBA) as the main disseminator of Libor quotes to that of a newly established agency, the ICE Benchmark Administration (IBA). The IBA is an independent UK subsidiary of the private U.S.-based exchange operator Intercontinental Exchange or ICE.

Moreover, ICE calculates Libor by the following:

Screenshot 2017-12-10 11.58.19Screenshot 2017-12-10 11.58.37

Therefore, the methodology in calculating Libor (so I can wrap my head around it) is again, a representative panel of global banks:

Screenshot 2017-12-10 12.01.04

; submit an estimate of their borrowing costs to the Thompson Reuters data collection service each morning at 11:00 a.m. The calculation agent throws out the highest and lowest 25 percent of submissions and then averages the remaining rates to determine Libor. This methodology is applied to the calculation of five different currencies- the U.S. dollar, the euro, the British pound sterling, the Japanese yen, and the Swiss franc- at seven different maturity lengths from overnight to one year.

So that bedrock of understanding built up my confidence to branch out a little farther and explore the EONIA overnight Index average, which is a reference rate calculated by the European Central Bank as the average rate of overnight inter-bank lending transactions undertaken by a panel of declaring banks in the Eurozone. It is a benchmark rate in the euro money market, and Eurex offers futures based on the monthly average of published EONIA rates.

Righto, so that leads me to back the inflection point of realized non-awareness and understanding. Bloomberg first came out with this newsflash.

Here is Mr. White of the Heisenberg Report , to explain further that this may or may not be just an “idiosyncratic” event. That of which was probably known to a deeper extent by Richard Jones than he was reporting. But just wanted to say, “idiosyncratic.” I don’t blame him when I say it makes me feel like Alan Greenspan. I digress. 

(11/30/17) “..the euro surged and there’s significant chatter about shenanigans in European money markets as an unexplained jump in Eonia has everyone scratching their heads. Thursday’s fix was 6bps higher at -0.241% – that would be the highest since March 9 of last year and it comes hot on the heels of Wednesday’s 6.1bp move higher. Note that the euro’s leg up comes after a disappointing inflation print, which would seem to suggest that something else is indeed amiss:


(12/01/17) “If it turns out that the spike in Eonia fixings is not just an idiosyncratic matter and these higher rates become the new norm, it will have some significant implications across markets,” one short-end trader told Bloomberg’s Richard Jones this morning. “Most at risk is the positive roll-down on the curve, whereby traders lend out cash in advance (ie receive the periods) and borrow it back more cheaply day-by-day (ie pay the lower daily fixing rate). A disruption of that trade would cause substantive pain in the euro STIR markets, upending markets as traders are stopped out of positions.”

And of course, as noted yesterday afternoon, if short-end rates move in favor of the single-currency, that could catalyze a further rally in the euro and potentially exacerbate weakness in European shares.

“The most plausible interpretation is borrowing from one or several non-European banks, possibly EM,” SocGen mused, adding that “the massive spike in fixings underlies the fragility of the Eonia benchmark in the current context of high excess liquidity and low volumes in the O/N unsecured lending segment.”

  • Mr. White

Ann, in fact, the very next day Bloomberg seemed to have found the catalytic event that caused the EONIA rate to spike, that being the result of excess liquidity injected into the market by Greece’s second-biggest lender, National Bank of Greece SA, at above-average rates.

Here’s Bloomberg’s Nikos Chrusoloras and Sotiris Nikas with their findings:

National Bank of Greece SA had excess liquidity of around 450 million euros ($535 million) this week, which it loaned to its peers in the country, the people said. While the flood of funds and the increase in interbank lending in Greece is good news, the rates at which borrowers from the country can access funds are still higher than for the rest of the continent, thus pushing up the weighted average of the overnight rates in Europe, one of the people said. A National Bank of Greece spokesman couldn’t be reached for comment.

Eonia, the effective overnight reference rate for the euro, “is computed as a weighted average of all overnight unsecured lending transactions in the interbank market,” according to the European Money Markets Institute. A sudden surge of activity in Greece, where rates are higher, could explain the spike in the weighted average over Wednesday and Thursday. The rate fell by five basis points at Friday’s setting, returning closer to normal levels.

The rate was set at -0.291 percent Friday after jumping 12 basis points in the past two days. Thursday’s fix rose six basis points to -0.241 percent, the highest since March 2016. A move on that scale would normally be justified only by a shift in the European Central Bank’s benchmark rate or by funding stress among the banks.

Righto, so this reminds me of the trader’s front-running the large U.S. money centers when it is deemed they are in need of a greater short-term funding facility.

This leads me to Duffie, Dworczak , and Zhu and their model on Benchmarks being introduced in Search Markets.


Here is the abstract:

We characterize the role of benchmarks in price transparency of over-the-counter markets. A benchmark can raise social surplus by increasing the volume of benefical trade, facilitating more effienct matching between dealers and customers, and reducing search cocts. Although the market transparency promoted by benchmarks reduces dealers’ profit margins, dealers may nonetheless introduce a benchmark to enourage greater market participation by investors. Low-cost dealers may also introduce a benchmark to increase their market share relative to high-costs dealers. We construct a revelation mechanism that maximizes welfare subject to search frictions, and show conditions under which it coincides with announcing the benchmark.

Copy that, Gentlemen.

What I am trying to draw a conclusion with, is that given the price transparencies distributed to all market participants of the once opaque transaction histories of OTC instruments. And taking the most recent event where  EONIA spreads expanded quickly, worrying market participants to what a rise in the spread of overnight reference indicates was quelled quickly and efficiently by the benchmarks themselves.

Which, noted by Duffie, Dworczak, and Zhu is why benchmarks are almost always benchmarks for OTC instruments are introduced by the dealers in these securities and not by any external regulatory pressures.

To wit, under natural parameter assumptions, Duffie, Dworczak , and Zhu say in the opening, we show that publishing the benchmark rate is socially efficient because of three types of effects.

  1. publication of the nenchmark encourages efficient entry by traders, thus increasing the realized gains from trade. ( who doesn’t like that!) The benchmark improves the information available to traders about the likely price terms they will face. This assists trader in deciding whether to participate in the market based on whether there is a sufficiently large conditional expected gain from trade. (In the EONIA rate example, “The initial jump had spurred speculation that there was an error in the calculation of the benchmark, though the EMMI, which helps compute the rate, quickly ruled that out.) The increased transparency
  2. Benchmarks improve matching efficiency, which leads to a higher market share for low-cost dealers.  “Cui bono?” Everyone.
  3. Benchmarks reduce wasteful search by (i) alerting traders that gains from trade are too small to justify entry, (ii) helping traders infer whether they should stop searching because they have likely encountered a low-cost dealer.

The assertion or the third effect proposed by Duffie, Dworczak , and Zhu reminded me a lot of Brian Christian and Tom Griffiths book, Algorithms to Live By,


specifically Chapter 2 entitled, Explore/Epolit: The latest vs. the Greatest. Where they describe searching for real estate and the optimal stopping problem. It’s a great book, I highly recomend it. For whatever that’s worth.


In summation, I realize I just broke the surface in this topic but in doing so it helped me learn more about interbank lending rates and their significance in affecting the global borrowing rates and world economies as a whole.

  • R.W.N II
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