Full text of Research Update : January 2002

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January 2002

Research
U P D AT E
f ro m t h e Fe d e ra l Re s e r ve B an k of Ne w Yo r k
RESEARCH AND MARKET ANALYSIS GROUP

w w w. n e w y o r k f e d . o r g / r m a g h o m e

Acceptance of New Internet Payment Method Will Hinge
on System Compatibility and Risk Management
By tapping the Internet’s unique potential for
speed and convenience, personal on-line payments have emerged as a convenient
alternative to cash, check, and credit card
transactions for those wishing to initiate and
confirm small retail payments. However, the
ultimate success of personal on-line payments will depend on greater interoperability
of the payment providers’ diverse systems and
on risk management, according to a new article
in the Economic Policy Review (“Personal
On-Line Payments,” vol. 7, no. 3).

nonbank providers,” observe Kuttner and
McAndrews.
The authors identify several steps that
nonbank on-line payment providers could
take—short of adopting a common clearing
system—to improve system interoperability.
These include holding accounts in a common
bank, using a bank to make interbank funds
transfers on the providers’ behalf, and establishing a clearing house arrangement for
netting and settling payments.

Kuttner and McAndrews also suggest that
Authors Kenneth Kuttner and James
personal on-line payments are unlikely to
McAndrews explain that all personal on-line
have a significant impact on monetary policy.
payment systems rely on web and e-mail
However, they contend that this new payment
technologies to initiate and confirm paymethod does raise regulatory issues related
ments. Yet the systems differ in terms of the
to such concerns as consumer protection
types of accounts they access—some of which
rights and the insurability of deposits in the
are maintained by banks, others by nonbanks.
providers’ on-line accounts.
Because the latter do not participate in a
common clearing system, the
transmission of payments between
Also in This Issue…
nonbanks is a cumbersome
Current Issues examines results of bank survey
process. Therefore, “increased
on stress tests
2
acceptance of this payment
Papers
recently
published
by
RMAG
staff
3
method will depend on effecNew
Staff
Reports
5
tive risk control and improved
Papers presented at conferences
6
settlement arrangements among

Ne w Research: October–December 2001

Federal Reser ve Bank of Ne w York

Survey of Stress Tests Casts Light on Banks’ Risk Concerns
In the summer of 2000, central banks from the
G-10 countries surveyed large international
banks about their use of stress tests—a tool
that measures how the value of a firm’s
portfolio will be affected by extreme financial
or economic events. The object of the survey
was to learn more about the types of shocks
that most concern banks and to determine
how banks use stress tests in their risk management programs.
In a review of the survey and its findings
(“An International Survey of Stress Tests,”
Current Issues in Economics and Finance,
vol. 7, no. 10), Ingo Fender, Michael Gibson,
and Patricia Mosser report that stock market
crashes and emerging market crises head the
list of events that concern banks. But while
such scenarios are the most commonly simulated, the risks covered by respondents’ stress
tests span all major asset classes and all
geographic areas.

According to the authors, the survey shows
broad similarities in the types of risks tested
by banks. Nevertheless, individual stress test
scenarios differ across banks, with marked
variations evident in the size of the shocks
simulated and the assumptions made about
cross-market effects. These variations, the
authors note, reflect differences in the underlying portfolios and business lines of the
institutions surveyed, as well as differences in
the time horizons used in the tests.
In discussing how banks use stress tests,
Fender, Gibson, and Mosser observe that
banks rely on this tool to assess exposures in
those asset markets where illiquid conditions
and poor historical data make the use of other
risk measures difficult. In addition, because
stress tests provide a direct measure of a
potential loss in portfolio value, bank risk
managers regard the tests as an especially
effective means of communicating risk to
senior management.

Publications 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.
• Current Issues in Economics and Finance—a newsletter-style publication offering
concise and timely analyses of economic and financial topics.
• Second District Highlights—a regional supplement to Current Issues covering financial
and economic developments in the Federal Reserve System’s Second District.
• Staff Reports—technical papers intended for publication in leading economic
and finance journals. This series is available only on-line.
• Publications & Other Research—an annual catalogue of the Group’s research output.

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Recently Published
Sandra Black. 2001. “The Division of Spoils:
Rent-Sharing and Discrimination in a Regulated
Industry,” with Philip Strahan. American Economic
Review 91, no. 4 (September): 814-31.

Linda Goldberg. 2001. “Employment versus Wage
Adjustment and the U.S. Dollar,” with José Campa.
Review of Economics and Statistics 83, no. 3
(August): 477-89.

Sandra Black. 2001.“How to Compete: The Impact of
Workplace Practices and Information Technology on
Productivity,” with Lisa Lynch. Review of Economics
and Statistics 83, no. 3 (August): 434-45.

Linda Goldberg. 2001. Comment on “Exchange Rate
Variability and Investment in Canada,” by Robert
Lafrance and David Tessier. In Revisiting the Case
for Flexible Exchange Rates, 269-75. Proceedings of
a conference sponsored by the Bank of Canada.
Ontario, Canada: Bank of Canada.

Arturo Estrella. 2001. “Financial Innovation and the
Monetary Transmission Mechanism.” In Martin
Schuerz and Maria Teresa Valderrama, eds., Aspects
of the Transmission of Monetary Policy, 111-28.
Vienna: Oesterreichische Nationalbank.
Arturo Estrella. 2001. “Mixing and Matching:
Prospective Financial Sector Mergers and Market
Valuation.” Journal of Banking and Finance 25,
no. 12 (December): 2367-92.
Arturo Estrella. 2001. Comment on “A Regulatory
Regime for Financial Stability,” by David Llewellyn.
In The Single Financial Market: Two Years into
EMU, 134-41.Vienna: Oesterreichische Nationalbank.
Kenneth Garbade. 2001. Pricing Corporate Securities
as Contingent Claims. Cambridge: MIT Press.
Linda Goldberg. 2001. “Does Foreign Ownership
Contribute to Sounder Banks? The Latin American
Experience,” with Jennifer Crystal and B. Gerard
Dages. In R. Litan, M. Pomerleano, and P. Masson,
eds., Open Doors: Foreign Participation in
Emerging Financial Systems, 217-66. Proceedings of
a joint meeting of the World Bank, the International
Monetary Fund, and the Brookings Institution.
Washington, D.C.: Brookings Institution.

Kenneth Kuttner. 2001. “Beyond Bipolar: A ThreeDimensional Assessment of Monetary Frameworks,”
with Adam S. Posen. International Journal of
Finance and Economics 6, no. 4: 369-87.
Martin Lettau and Sydney Ludvigson. 2001.
“Resurrecting the (C)CAPM: A Cross-Sectional Test
When Risk Premia Are Time-Varying.” Journal of
Political Economy 109, no. 6 (December): 1238-87.
Sydney Ludvigson. 2001. “Does Buffer-Stock Saving
Explain the Smoothness and Excess Sensitivity
of Consumption?” with Alexander Michaelides.
American Economic Review 91, no. 3 (June): 631-47.
Sydney Ludvigson. 2001. “Elasticities of Substitution
in Real Business Cycle Models with Home
Production,” with John Y. Campbell. Journal of
Money, Credit, and Banking 33, no. 4 (November):
847-75.
Donald Morgan and Kevin Stiroh. 2001.“Bond Market
Discipline of Banks: The Asset Test.” Journal of
Financial Services Research 20, no. 2-3: 195-208.

www.ne wyorkfed.org/r maghome

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Federal Reser ve Bank of Ne w York

Richard Peach and Stavros Peristiani. 2001.
“Structural Change in the Mortgage Market and the
Propensity to Refinance,” with Paul Bennett. Journal
of Money, Credit, and Banking 33, no. 4 (November):
955-75.
Paolo Pesenti. 2001. “Fundamental Determinants of
the Asian Crisis: The Role of Financial Fragility and
External Imbalances,” with Giancarlo Corsetti and
Nouriel Roubini. In Takatoshi Ito and Anne O.
Krueger, eds., Regional and Global Capital Flows:
Macroeconomic Causes and Consequences, 11-41.
NBER conference volume. Chicago: University of
Chicago Press.
Simon Potter. 2001. “Nonlinear Risk,” with Marcelle
Chauvet. Macroeconomic Dynamics 5, no. 4
(September): 621-46.
Simon Potter. 2001. “Recent Changes in the U.S.
Business Cycle,” with Marcelle Chauvet. Manchester
School of Economic and Social Studies 69, no. 5:
481-508.

International Encyclopedia of Business and
Management, 342-52. London: Thomson Learning.
João Santos. 2001. “O Euro e o Sistema Financeiro da
Zona Euro” (“The Euro and the Financial System of
the Euro-Zone”). Journal of the Portuguese
Securities Market 10 (April): 119-34.
Charles Steindel. 2001. Comment on “The
Productivity Paradox and the Mismeasurement of
Economic Activity,” by W. E. Diewert and Kevin J. Fox.
In Kunio Okino and Tetsuya Inoue, eds., Monetary
Policy in a World of Knowledge-Based Growth,
Quality Change, and Uncertain Measurement,
198-201. New York: Palgrave.
Charles Steindel and Kevin Stiroh. 2001.
“Productivity: What Is It, and Why Do We Care about
It?” Business Economics 36, no. 4 (October): 13-31.
Kevin Stiroh. 2001. “Do Computers Make Output
Harder to Measure?” with Robert H. McGuckin.
Journal of Technology Transfer 26, no. 4 (October):
295-321.

João Santos. 2001. “Bank of England in Central
Banking Theory.” In Malcolm Warner, ed.,

Ot her New Publicat ions
●

An Introduction to Economic Research at the Federal Reserve Bank of New York: An html
document 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

●

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 2001 issue examines the distinctive patterns of the economic restructurings
of Buffalo and Rochester.
www.newyorkfed.org/rmaghome/regional/newsletter.html

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New Titles in the Staff Reports Series
The following new Staff Reports are available at
www.newyorkfed.org/rmaghome/staff_rp/.

Macroeconomics and Growth
No. 139
Is Equipment Price Deflation a Statistical
Artifact?
Bart Hobijn
The author argues that equipment price deflation might be overstated because the methods
used to measure it rely on the erroneous
assumption of perfectly competitive markets.
The main intuition behind this argument is
that what these price indices might actually
capture is not a price decrease but the erosion
of the market power of existing vintages of
machines. To illustrate this, the author introduces an endogenous growth model in which
heterogeneous final goods producers can
choose their technology, which is provided by
monopolistically competing machine suppliers. This market structure implies that the best
machines are marketed to the best workers
and sold at the highest markup. In the model’s
economy, the endogenously determined
markups are such that standard methods will
tend to find equipment price deflation, even
though the model exhibits no such deflation.

International
No. 140
Specialization and the Volume of Trade:
Do the Data Obey the Laws?
James Harrigan
The core subjects of trade theory are the pattern and volume of trade: which goods are
traded by which countries, and how much of
those goods is traded. The first part of this

paper discusses evidence on comparative
advantage, with an emphasis on carefully connecting theoretical models with data analyses.
The second part considers the theoretical
foundations of the gravity model and reviews
the small number of studies that have tried to
test, rather than simply use, the implications
of gravity. Both parts of the paper yield the
same conclusion: we are still in the very early
stages of empirically understanding specialization and the volume of trade, but the work
to date can serve as a starting point for further
research.
No. 142
One Reason Countries Pay Their Debts:
Renegotiation and International Trade
Andrew K. Rose
This paper estimates the effect of sovereign
debt renegotiation on international trade.
Sovereign default may be associated with a
subsequent decline in international trade
either because creditors want to deter default
by debtors, or because trade finance dries up
after default. To estimate the effect, the author
uses an empirical gravity model of bilateral
trade and a large panel data set covering fifty
years and more than 200 trading partners. The
model controls for various factors that influence bilateral trade flows, including the
incidence of International Monetary Fund
programs. Using the dates of sovereign debt
renegotiations conducted through the Paris
Club as a proxy measure for sovereign default,
the author finds that renegotiation is associated with an economically and statistically
significant decline in bilateral trade between a
debtor and its creditors. The decline is approximately 8 percent a year and persists for about
fifteen years.

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5

Federal Reser ve Bank of Ne w York

Banking and Finance
No. 141
Common Determinants of Bond and Stock
Market Liquidity: The Impact of Financial
Crises, Monetary Policy, and Mutual Fund Flows
Tarun Chordia, Asani Sarkar,
and Avanidhar Subrahmanyam
The authors study common determinants of
daily bid-ask spreads and trading volume for
the bond and stock markets over the 1991-98
period. They find that spread changes in one
market are affected by lagged spread and volume changes in both markets. Further, spread
and volume changes are predictable to a con-

siderable degree using lagged market returns,
lagged interest rates, lagged spreads, and
lagged volume. During financial crises, stock
and bond spreads and volume are more
volatile and become more highly correlated;
moreover, money supply positively affects
financial market liquidity, albeit with a twoweek lag. During normal times, increases in
mutual fund flows enhance stock market
liquidity and trading volume, but during
financial crises, U.S. government bond funds
see higher inflows, resulting in increased bond
market liquidity.

Papers Presented by Economists in the Research
and Market Analysis Group

6

“Financial Innovation and the Monetary Transmission Mechanism,” Arturo Estrella. Workshop of
Volkswirtcshaft Abteilung, Oesterreichische Nationalbank,Vienna,Austria, November 9.

“Distance, Time, and Specialization,” Carolyn Evans
and James Harrigan. National Bureau of Economic
Research International Trade and Investment Group
Conference, Palo Alto, California, December 7.

This paper lays out an analytical framework to
examine the transmission mechanism and how each of
several forms of financial innovation has affected the
elements of the framework in recent decades.

The authors present evidence that time-sensitive
products are being increasingly sourced from places
close to the United States, supporting their argument
that distance can become more—not less—important
as transport and communication costs fall.

“The Monetary Transmission Mechanism: Has It
Changed?” Marc Giannoni. Rutgers University
Department of Economics Seminar, New Brunswick,
New Jersey, October 9.With Jean Boivin.

international monetary cooperation are related in a
nonmonotonic way to the degree of exchange rate
pass-through.

The study argues that the reduced estimated effect
of exogenous interest rate fluctuations in the United
States since the early 1980s can be attributed to
changes in the systematic elements of monetary policy.

“Explaining the Low U.S. Unemployment Rate of the
1990s,” Simon Potter. New School University Seminar,
New York City, October 22. With Marcelle Chauvet and
Chinhui Juhn.

“‘Too Big to Fail’ and Market Discipline of Banks: A
Cross-Sector Investigation,” Don Morgan and Kevin
Stiroh. Fifty-Second International Atlantic Economic
Conference, Philadelphia, Pennsylvania, October 13.
Also presented at Rutgers University Department of
Economics Seminar, December 14.
Using data on bond spreads and ratings,the authors
find evidence that the risk of banks seen as “too big to
fail” receives more lenient pricing than the risk of
smaller banks and nonbanks.
“International Dimensions of Optimal Monetary
Policy,” Paolo Pesenti. University of WisconsinMadison Department of Economics Seminar,Madison,
Wisconsin, October 16. Also presented at Boston
College Department of Economics Seminar, Boston,
Massachusetts, November 7.With Giancarlo Corsetti.
The paper shows that optimal monetary rules for
interdependent economics trade off a larger domestic
output gap against lower import prices. Gains from

The authors find evidence that workers’ educational levels and age, along with the long economic
expansion of the 1990s, help account for the low U.S.
unemployment rate in the decade.
“Welfare Reform, Economic Growth, and Disadvantaged Households in New York City,” Carol
Rapaport. Graduate Center of the City University of
New York Seminar, New York City, December 4.
This study shows how the combination of strong
economic growth and welfare reform resulted in a
decrease in the welfare caseload and an increase in
employment between 1996 and 1999 in New York City.
“Exclusive Dealing,” Chris Stefanadis. Indiana
University-Bloomington Business Economics Seminar,
Bloomington, Indiana, October 28.With Jay Pil Choi.
The paper argues that free riding—rather than
efficiency gains—may be the driving force behind
anticompetitive exclusive dealing.

www.ne wyorkfed.org/r maghome

7

Federal Reser ve Bank of Ne w York

RESEARCH AND MARKET ANALYSIS GROUP
PUBLICATIONS AND PAPERS:
October-December 2001
Publications are available at www.newyorkfed.org/
rmaghome/publications.html. You can also
subscribe to publications or obtain many back
issues from our web site.

Economic Policy Review, Vol. 7, No. 3
Infrastructure and Social Welfare
in Metropolitan America
Andrew F. Haughwout
The Effect of Employee Stock Options on the
Evolution of Compensation in the 1990s
Hamid Mehran and Joseph Tracy
Personal On-Line Payments
Kenneth N. Kuttner and James J. McAndrews
The Effect of Interest Rate Options Hedging
on Term-Structure Dynamics
John Kambhu and Patricia C. Mosser

Current Issues in Economics
and Finance, Vol. 7

Staff Reports
Available only on-line.
No. 139
Is Equipment Price Deflation a Statistical
Artifact?
Bart Hobijn
No. 140
Specialization and the Volume of Trade:
Do the Data Obey the Laws?
James Harrigan
No. 141
Common Determinants of Bond and Stock
Market Liquidity: The Impact of Financial
Crises, Monetary Policy, and Mutual Fund Flows
Tarun Chordia, Asani Sarkar,
and Avanidhar Subrahmanyam
No. 142
One Reason Countries Pay Their Debts:
Renegotiation and International Trade
Andrew K. Rose

No. 10
An International Survey of Stress Tests
Ingo Fender, Michael S. Gibson,
and Patricia C. Mosser
No. 11
The Effect of Tax Changes on Consumer
Spending
Charles Steindel

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.