Index Theory: The Law, Promise and Failure of Financial Indices

Abstract

Financial indices, like the S&P 500 or the Consumer Price Index, have become a ubiquitous feature of our financial markets. One index, the London InterBank Offered Rate ("Libor"), may be the world's most important number, an interest rate benchmark upon which hundreds of trillions of dollars depend. Yet, almost every day new revelations emerge that Libor was tampered with during the height of the financial crisis by one or many of the world's most prominent banks, with billions of dollars potentially misappropriated. This index disruption has attracted tremendous interest from regulators, private litigants, and market observers. Despite their importance, however, financial indices are poorly understood, and almost completely unstudied. In this Article, we explain why and how people use financial indices as well as how they are created. We show human discretion and value judgment to be essential ingredients in even the most "objective" indices. We then develop a taxonomy of financial indices, illustrating how the risks indices can pose, and the solutions applicable to those risks, are intimately related to the motivation that drives the index's creation. We show that the manipulation of indices is unsurprising given the precarious state of intellectual property rights in indices. While many call for prosecuting or regulating the Libor banks, our novel solution is to strengthen property rights for those who create financial indices.