Full text of Research Update : April 2003

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pril 2003

Federal Reserve Bank of New York

Update
Research and Market Analysis Group

www.newyorkfed.org/rmaghome

Market Risk Capital Holdings Offer Insight
into Bank Exposures
he amount of capital held by banks
to cover their market risk offers new
information about the market risk
exposures of these institutions, according
to a forthcoming Economic Policy Review
article.

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In “What Market Risk Capital
Reporting Tells Us about Bank Risk,”
Beverly Hirtle examines the market risk
capital figures reported to regulators by
U.S. bank holding companies. Her goal is
to assess the extent to which such disclosures, publicly available in regulatory
reports, provide meaningful information
about bank risk.

their market risk: the risk of loss arising
from adverse movements in financial rates
and prices. The mandatory disclosure of
these capital amounts is designed to ensure
the efficient operation of financial institutions by giving market participants access
to the information necessary to exercise
market discipline on the institutions’ risktaking activities.

Hirtle’s study concludes that market risk
capital figures do in fact provide new information about the evolution of individual
banks’ risk exposures. In particular,
changes in an institution’s capital charges
are found to be a strong predictor of
changes in the volatility of its future tradSince 1998, bank holding companies
ing revenue. By contrast, the study finds
with large trading operations have been
that the figures provide little information
required to hold capital sufficient to cover
about differences in market risk exposures
across institutions beyond
what is already conveyed by
ew Research: January–March 2003
the relative size of an instituRecent rise in U.S. foreign debt is examined
tion’s trading account.
in Current Issues
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The article is available at
New Staff Reports
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w w w. n e w y o r k f e d . o r g /
Papers recently published by RMAG staff
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rmaghome/econ_pol/
Papers presented at conferences
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indexfc.html.

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April 2003

Exchange Rate Movements Help Explain the Recent
Surge in U.S. Foreign Debt
y the end of 2001, the nation’s net
debt to the rest of the world had
risen to $2.3 trillion, more than
double its level two years earlier. In “The
Impact of Exchange Rate Movements on
U.S. Foreign Debt” (Current Issues in
Economics and Finance, vol. 9, no. 1),
Cédric Tille argues that a third of this steep
increase can be traced to a simple accounting effect—the impact of a rising dollar on
the value of U.S. gross assets.

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As Tille explains, U.S. net debt is calculated as the difference in value between
U.S. gross assets (U.S. holdings of foreign
securities) and U.S. gross liabilities (foreign
holdings of U.S. securities). To determine
why the country’s debt accelerated so
sharply in recent years, the author looks at
the two mechanisms that affect assets and liabilities—financial flows and valuation
changes.
Tille finds that financial flows—
specifically, new funds borrowed by the

United States to finance its current account
deficit—were the primary force behind the
worsening of the country’s foreign debt in
the 1990-2001 period. From the end of
1999 through 2001, however, valuation
changes also played a key role. The appreciation
of the dollar, which averaged 6.8 percent
per year over the two-year period, markedly
reduced the dollar value of the foreign
securities held by U.S investors. At the
same time, it did little to lessen U.S. liabilities,
which are largely denominated in dollars and
thus insulated from changes in the dollar’s
value.
Tille’s calculations indicate that the
strong dollar explained a third of the jump
in U.S. net debt after 1999. “If one-third of
the 1999-2001 acceleration reflects an
accounting effect,” the author concludes,
“the rapid increase in the U.S. net foreign
debt may be a somewhat less formidable
problem than is often assumed.”

P ublications and Papers
The Research and Market Analysis Group produces a wide range of publications:
● The Economic Policy Review—a policy-oriented journal focusing on economic
and financial market issues.
●

EPR Executive Summaries—on-line versions of selected Economic Policy Review
articles, in abridged form.

●

Current Issues in Economics and Finance—concise studies of topical economic
and financial issues.

●

Second District Highlights—a regional supplement to Current Issues covering
financial and economic developments in the Federal Reserve’s Second District.

●

Staff Reports—technical papers intended for publication in leading economic
and finance journals. Available only on-line.

●

Publications and Other Research—an annual catalogue of the Group’s research output.

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New Titles in the
Staff Reports Series
Macroeconomics and Growth
No. 159, January 2003

Tracking the New Economy: Using Growth
Theory to Detect Changes in Trend
Productivity
James A. Kahn and Robert Rich
Kahn and Rich propose a methodology that
draws on growth theory to identify variables
other than productivity—namely, consumption and labor compensation—to estimate
trend productivity growth. They treat that
trend as a common factor with two “regimes,”
high- and low-growth. The authors find evidence of a switch in the mid-1990s to a higher
long-term growth regime, as well as a switch in
the early 1970s in the other direction. In addition, they find that productivity data alone
provide insufficient evidence of regime
changes; corroborating evidence from other
data is crucial in identifying changes in trend
growth. Kahn and Rich argue that their
methodology would also detect trend changes
in real time: For the 1990s, it would have
detected a switch within two years of its occurrence, according to subsequent data.

Banking and Finance
No. 158, January 2003

Fifteen Minutes of Fame? The Market Impact
of Internet Stock Picks
Peter Antunovich and Asani Sarkar
The authors examine 120 Nasdaq and overthe-counter “buy” recommendations by
Internet sites from April 1999 to June 2001.
The stock picks show substantial short- and
long-run price and liquidity gains, although no
new information is revealed about them. For
example, liquidity one year after the pick day
remains higher for these stocks than for a sample
matched according to size, book-to-market
value, and liquidity in the preceding year. After
controlling for fundamental and microstructure factors, the study also finds that stocks

with lower initial liquidity have greater
improvements in liquidity on the pick day,
while stocks with lower initial liquidity and
higher pick-day liquidity have higher pick-day
excess returns. These results suggest that stocks
have multiple liquidity equilibria, and that the
stock picks, by coordinating uninformed trading activity, push initially illiquid stocks to a
higher liquidity equilibrium.
No. 160, February 2003

Endogenous Deposit Dollarization
Christian Broda and Eduardo Levy Yeyati
This paper explores sources of deposit dollarization
unrelated to standard moral hazard arguments.
The authors develop a model in which banks
choose the optimal currency composition of
their liabilities. They argue that the equal
treatment of peso and dollar claims in the
event of bank default can induce banks to
attract dollar deposits above the socially desirable level. The distortion arises because dollar
deposits are the only source of default risk in
the model, but dollar depositors share the burden of the default with peso depositors. The
incentive to dollarize is reinforced by common
banking system safety nets, such as deposit and
bank insurance. These findings suggest that
regulators in bicurrency economies would
potentially benefit by departing from the
currency-blind benchmark and differentiating
among currencies in a way that prevents undesirable currency mismatches.
No. 164, March 2003

An Empirical Analysis of Stock
and Bond Market Liquidity
Tarun Chordia, Asani Sarkar,
and Avanidhar Subrahmanyam
This paper explores liquidity movements in
stock and Treasury bond markets over more
than 1,800 trading days. Cross-market dynamics in liquidity are estimated using a vector
autoregressive model for liquidity, returns,
volatility, and order flow. The paper finds that
a shock to quoted spreads in one market affects
spreads in both markets, and that return

Research and Market Analysis Group

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Research Update

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April 2003

volatility is an important driver of liquidity.
Innovations to stock and bond market liquidity and volatility prove to be significantly correlated, suggesting that common factors drive
liquidity and volatility in both markets.
Monetary expansion increases equity market
liquidity during financial crises, and unexpected
increases (decreases) in the federal funds rate
lead to decreases (increases) in liquidity and
increases (decreases) in stock and bond volatility. Finally, flows to the stock and government
bond sectors play an important role in forecasting stock and bond liquidity.

Quantitative Methods
No. 161, February 2003

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Modeling Uncertainty: Predictive Accuracy
as a Proxy for Predictive Confidence
Robert Rich and Joseph Tracy
The authors evaluate current strategies for the
empirical modeling of forecast behavior. They
focus on the reliability of using proxies from
time series models of heteroskedasticity to
describe changes in predictive confidence. To
do so, they examine the relationship between
ex-post inflation forecast errors and ex-ante
measures of inflation uncertainty using data
from the Survey of Professional Forecasters.
The results provide little evidence of a strong
link between observed heteroskedasticity in
the consensus forecast errors and forecast
uncertainty. Instead, they indicate a significant
link between observed heteroskedasticity in
the consensus forecast errors and forecast dispersion. The authors conclude that conventional model-based measures of uncertainty
may be capturing not the degree of confidence
that individuals attach to their forecasts, but the
degree of disagreement across individuals.
No. 162, March 2003

Nonparametric Pricing of Multivariate
Contingent Claims
Joshua V. Rosenberg
Rosenberg derives and implements a nonparametric, arbitrage-free technique for multivariate contingent claim pricing. Using results

Federal Reserve Bank of New York

from the method of copulas, he shows that the
multivariate risk-neutral density can be written as a product of marginal risk-neutral densities and a risk-neutral dependence function.
He then develops a pricing technique using
nonparametrically estimated marginal riskneutral densities and a nonparametric dependence function to estimate the joint risk-neutral
density of euro-dollar and yen-dollar returns.
Rosenberg compares the nonparametric riskneutral density with density based on a lognormal dependence function and nonparametric marginals. The nonparametric euroyen density has greater volatility, skewness,
and kurtosis than the density based on a lognormal dependence function. For euro-yen
futures options, the nonparametric model’s
pricing accuracy is superior to that of the lognormal model.
No. 163, March 2003

Forecasting in Large Macroeconomic Panels
Using Bayesian Model Averaging
Gary Koop and Simon Potter
This paper considers the problem of forecasting in large macroeconomic panels using
Bayesian model averaging. It describes practical methods for implementing Bayesian model
averaging with factor models; the methods
involve algorithms that simulate from the
space defined by all possible models. The
authors explain how these algorithms can be
used to select the model with the highest marginal likelihood (or highest value of an information criterion). They use these methods to
forecast GDP and inflation, relying on quarterly U.S. data on 162 time series. Models
containing factors outperform autoregressive
models in forecasting GDP and inflation, but
only narrowly and at short horizons. The
authors attribute this finding to the presence
of structural instability and the fact that lags of
the dependent variable seem to contain most
of the information relevant for forecasting.

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Recently Published
Joshua Rosenberg. 2003. “Nonparametric
Pricing of Multivariate Contingent Claims.”
Journal of Derivatives 10, no. 3 (spring): 9-26.
Chris Stefanadis. 2003. “Self-Regulation, Innovation, and the Financial Industry.”
Journal of Regulatory Economics 23, no. 1
(January): 5-25.

Other New Publications
Publications and Other Research. The 2002
edition of our catalogue lists all of the papers
published in our research series as well as many
papers published by our economists in
economic and finance journals, conference
volumes, and scholarly books.
www.newyorkfed.org/rmaghome/otherres/
An Introduction to Economic Research at the
Federal Reserve Bank of New York. An online guide designed to give economists interested in joining the Research and Market Analysis Group a fuller understanding of the Group’s
activities.
www.newyorkfed.org/rmaghome/
intro/research/rmagtoc.html

Cédric Tille. 2003. “Exchange Rate PassThrough and the Welfare Effect of the Euro,”
with Michael Devereux and Charles Engel.
International Economic Review 44, no. 1
(February): 223-42.
Kei-Mu Yi. 2003. “Can Vertical Specialization
Explain the Growth of World Trade?” Journal
of Political Economy 111, no. 1 (February):
52-102.

The Regional Economy of Upstate New York.
This quarterly newsletter, produced by the
New York Fed’s Buffalo Branch, focuses on
issues of importance to upstate New York. The
fall 2002 issue examines the medical manufacturing industry’s presence in the region; the
winter 2003 issue evaluates the volatility of
employment in New York State.
www.newyorkfed.org/rmaghome/
regional/newsletter.html

Su b s c r i b e t o E l e c t r o n i c A l e r t
Visit www.newyorkfed.org/rmaghome/subscribe/subscribe.html
and join our free Electronic Alert service.
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Receive timely e-mails announcing new research publications posted
on our web site.

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Read short descriptions of the new postings.

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Learn in advance of upcoming conferences and calls for papers.

Research and Market Analysis Group

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Research Update

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April 2003

Papers Presented by
Economists in the
Research and Market
Analysis Group
“Overview of the International Wage Flexibility Project,” Erica Groshen. American Economic Association 2003 Annual Meeting,
Washington, D.C., January 6. With William
Dickens.
“Embodied Technological Change in U.S.
Manufacturing,” Bart Hobijn. Fifth Louvain
Symposium on Economic Dynamics, Université catholique de Louvain, Louvain-la-Neuve,
Belgium, January 31. With Ana Maria Oviedo
and Ashwin Vasan.

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“What Explains the Stock Market’s Reaction
to Federal Reserve Policy?” Kenneth Kuttner.
Federal Reserve Bank of San Francisco and
Stanford Institute for Economic Policy
Research Conference on Finance and Macroeconomics, February 28. With Ben S.
Bernanke.
“International Transmission with Trade and
Financial Frictions,” Paolo Pesenti. American
Economic Association 2003 Annual Meeting,
Washington, D.C., January 5. With Giancarlo
Corsetti, Luca Dedola, and Sylvain Leduc.
“Globalization and the Transmission Mechanism,” Paolo Pesenti. American Economic
Association 2003 Annual Meeting, Washington, D.C., January 6. With Giancarlo Corsetti
and Philippe Martin.
“Monetary Rules for Small, Open, Emerging
Economies,” Paolo Pesenti. International Monetary
Fund research seminar, Washington, D.C.,
January 17. Also presented at the University of
Cambridge, Cambridge, England, February 7;
the Bank of England, London, February 10;
and the London School of Economics, London,
February 11.

Federal Reserve Bank of New York

“Fifteen Minutes of Fame? The Market Impact
of Internet Stock Picks,” Asani Sarkar. American Finance Association 2003 Annual Meeting, Washington, D.C., January 3. With Peter
Antunovich.
“Estimation of Credit Migration Matrices,” Til
Schuermann. Fourth Annual Risk Management Convention of the Global Association of
Risk Professionals, New York City, February 12.
With Yusuf Jafry.
“Do Community Banks Benefit from Diversification?” Kevin Stiroh. Journal of Financial
Services Research and Federal Reserve Bank of
Chicago conference, Chicago, March 17.
“Optimal Monetary Policy When the Nature
of Shocks Is Uncertain,” Cédric Tille. American Economic Association 2003 Annual Meeting, Washington, D.C., January 4.
“A Simple Explanation of the Border Effect,”
Kei-Mu Yi. American Economic Association
2003 Annual Meeting, Washington, D.C.,
January 4.
“Insurance, Self-Protection, and the Economics
of Terrorism,” George Zanjani. NBER Insurance
Project Workshop, Cambridge, Massachusetts,
January 31. With Darius Lakdawalla.
“The Impact of Liquidity on Household Balance Sheets: Micro Responses to a Credit Card
Supply Shock,” Jonathan Zinman. American
Economic Association 2003 Annual Meeting,
Washington, D.C., January 5.

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Staff Reports

Publications and Papers:
January-March 2003

Available only from our web site.

Publications are available at www.newyorkfed.org/
rmaghome. You can also subscribe to most
publications from our site.

No. 158, January 2003

Fifteen Minutes of Fame? The Market Impact
of Internet Stock Picks
Peter Antunovich and Asani Sarkar

Economic Policy Review, Forthcoming

No. 159, January 2003

What Market Risk Capital Reporting
Tells Us about Bank Risk
Beverly J. Hirtle

Tracking the New Economy: Using Growth
Theory to Detect Changes in Trend Productivity
James A. Kahn and Robert Rich

Papers from a conference on economic
statistics:

No. 160, February 2003

Remarks on the Measurement, Valuation,
and Reporting of Intangible Assets
Baruch Lev
Productivity Measurement Issues in Services
Industries: “Baumol’s Disease” Has Been Cured
Jack E. Triplett and Barry P. Bosworth
Price Hedonics: A Critical Review
Charles R. Hulten

Current Issues in Economics
and Finance, Vol. 9
No. 1, January 2003

The Impact of Exchange Rate Movements
on U.S. Foreign Debt
Cédric Tille
No. 2, February 2003

New York City’s Economy before
and after September 11
Jason Bram
Second District Highlights

Endogenous Deposit Dollarization
Christian Broda and Eduardo Levy Yeyati
No. 161, February 2003

Modeling Uncertainty: Predictive Accuracy
as a Proxy for Predictive Confidence
Robert Rich and Joseph Tracy
No. 162, March 2003

Nonparametric Pricing of Multivariate
Contingent Claims
Joshua V. Rosenberg
No. 163, March 2003

Forecasting in Large Macroeconomic Panels
Using Bayesian Model Averaging
Gary Koop and Simon Potter
No. 164, March 2003

An Empirical Analysis of Stock and Bond
Market Liquidity
Tarun Chordia, Asani Sarkar,
and Avanidhar Subrahmanyam

No. 3, March 2003

Governing the Financial or Bank Holding
Company: How Legal Infrastructure Can
Facilitate Consolidated Risk Management
Thomas C. Baxter, Jr.

The views expressed in the publications and papers summarized in Research Update are those
of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York
or the Federal Reserve System.
Research and Market Analysis Group

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