Full text of Research Update : July 2001

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July 2001

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

High Stock Returns Drove the Rise in the Household
Equity Share in the 1990s
The growing prominence of stocks as a house-

increasingly larger share of the household

hold asset in the 1990s encouraged the view

asset portfolio in the 1990s primarily because

that vast numbers of Americans were eagerly

the returns on stocks were so much greater

tracking market developments and buying up

than those on other household investments

stocks. But in a new study (“Stocks in the

such as real estate or bonds. The authors’ sta-

Household Portfolio: A Look Back at the

tistical analysis reveals that differential asset

1990s,” Current Issues in Economics and

returns account for fully 53 percent of the rise

Finance, vol. 7, no. 4), Joseph Tracy and Henry

in the household equity share. A shift in

Schneider argue that exceptionally high

investment behavior, by contrast, explains

returns on equities—rather than aggressive

only 18 percent.

investment behavior—accounted for much of
the increased importance of stocks.

Although other factors—including the
rapid growth of the population in the 40 to 59

Using data on individual households from

age range and the restructuring of retirement

the Survey of Consumer Finances, the authors

plans—also contributed to the increased

show that the typical American investor reacted

importance of stocks, “the dominant factor by

to market trends “sluggishly”: “Most house-

far was the high relative return to equity.”

holds that owned some stocks during the
period did not rush to buy more,”
and “most households that
held no stocks refrained from
acquiring them.”
According

to

Tracy

and

Schneider, stocks claimed an

Also in This Issue…
New York Fed conference focuses on monetary policy
New Staff Reports
Other new publications
Papers presented at conferences
Papers recently published by RMAG staff

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Ne w Research: Apr il–June 2001

Federal Reser ve Bank of Ne w York

Monetary Policy, Viewed from Three Perspectives,
Is Subject of Fed Conference
The extraordinary financial innovation and
change that have occurred over the past few
years are likely to affect both the conduct and
the transmission of monetary policy. To offer
insight into the possible effects, the Research
and Market Analysis Group recently sponsored the conference “Financial Innovation
and Monetary Transmission.”
More than 100 representatives from central
banks, universities, and the private sector
attended the sessions, which were organized
around three themes: the reserves market, the
overall macroeconomic environment, and the
financial markets and institutions.

and consumption. Others argued that the
observed link between monetary policy and
the real economy might have changed for reasons unrelated to transmission changes. For
instance, changes in how the Federal Reserve
sets monetary policy in response to economic
news as well as structural changes—such as
improvements in inventory management that
have made the real economy less volatile—
were cited.

In the first session, the presenters examined how changes in the market for overnight
reserves, such as lower reserve requirements
and declining reserve balances, might affect
the implementation of monetary policy. Their
research indicated that these changes have
diminished the direct role of reserve balances
in policy implementation while augmenting
the importance of policy announcements.

The final session explored how trends in
financial markets and institutions might alter
the transmission mechanisms of monetary
policy. Among the trends considered were the
increase in securitization, the consolidation of
the financial services industry, and the
heightened importance of capital adequacy standards for financial institutions. The evidence
suggested that although securitization may
have reduced the impact of interest rates on
spending, changes in bank lending standards
have remained closely linked to lending and
economic activity.

Possible changes in the relationship
between macroeconomic variables and monetary policy were the focus of the second
session. Several papers documented changes
in the transmission mechanism to housing

The conference papers will be published in
an upcoming issue of the Bank’s Economic
Policy Review. Preliminary versions are
available at www.newyorkfed.org/pihome/
news/speeches/finmon/finmon.html.

Publications and Papers
The Research and Market Analysis Group produces a wide range of publications:
• The Economic Policy Review—a policy-oriented research journal focusing
on macroeconomic, banking, and financial market topics.
• 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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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. 122

Productivity: What Is It, and Why Do We Care
about It?
Charles Steindel and Kevin J. Stiroh

U.S. productivity growth has been the focus of considerable attention in recent years. This paper
presents a broad overview of productivity—both
labor and total factor—and discusses its importance.
The authors describe the official U.S. productivity statistics prepared by the Bureau of Labor Statistics and
discuss several stylized facts. They show how productivity relates to critically important variables like
long-run growth, living standards, and inflation, and
describe the proximate factors that determine labor
productivity using a standard growth accounting
framework. Finally, the authors outline a series of
unresolved productivity issues that have direct implications for the future of the U.S. economy.
No. 126

Recent Changes in the U.S. Business Cycle
Marcelle Chauvet and Simon Potter

The U.S. business cycle expansion, which started in
March 1991, is the longest on record. This study
examines whether the expansion is a onetime, unique
event or whether its length results from a change in
U.S. economic stability. Bayesian methods are used to
estimate a common factor model that allows for
structural breaks in the dynamics of a wide range of
macroeconomic variables. The study finds strong evidence that a reduction in volatility is common to the
series examined. Furthermore, the reduction implies
that future expansions will be considerably longer
than the historical average.
No. 131

A Primer on the Economics and Time Series
Econometrics of Wealth Effects: A Comment
Martin Lettau, Sydney Ludvigson,
and Nathan Barczi

In a recent paper,Davis and Palumbo (2001) investigate
the empirical relationship between aggregate con-

sumption, asset wealth, and labor income. Although
cointegration implies that an equilibrium relationship
ties these variables together in the long run, Davis and
Palumbo focus on a short-run structural question:
how quickly does consumption adjust to changes in
income and wealth—within a quarter, or over many
quarters? They claim to answer this question, and
imply that spending adjusts only gradually after gains
or losses in income or wealth have been realized. This
comment argues that a statistical methodology different from that of Davis and Palumbo is required to
address this question, and once the methodology has
been employed, the evidence weighs heavily against
their interpretation.

International
No. 121

Gender Differences in the Labor Market
Effects of the Dollar
Linda Goldberg and Joseph Tracy

Although the dollar has been shown to influence
workers’ expected wages, the analysis to date has
focused on the male workforce. This paper shows that
exchange-rate fluctuations also have important implications for women’s wages, particularly at job
transition. Changes in the dollar’s value can cause the
wage gap between women who change jobs and
women who do not to expand or contract sharply,
with the most pronounced effects occurring among
the least educated women and women in highly competitive manufacturing industries. In addition,
women who remain in their jobs apparently show
greater wage sensitivity to currency movements than
do their male counterparts.
No. 124

International Dimensions of Optimal
Monetary Policy
Giancarlo Corsetti and Paolo Pesenti

The authors argue that strict adherence to inwardlooking policy objectives such as domestic output
stabilization cannot be optimal when firms’ markups
are exposed to currency fluctuations. Such policies
induce excessive volatility in exchange rates and foreign sales revenue, leading exporters to raise prices in
response to higher risk. In general, optimal rules

www.ne wyorkfed.org/r maghome

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Federal Reser ve Bank of Ne w York

trade off a larger domestic output gap against lower
import prices. Monetary rules in a world Nash equilibrium lead to less exchange-rate volatility than
inward-looking rules and discretionary policies, even
when the latter do not suffer from inflationary (or
deflationary) bias. Gains from international monetary cooperation are related in a nonmonotonic way
to the degree of exchange-rate pass-through.
No. 125

Currency Orders and Exchange-Rate
Dynamics: Explaining the Success
of Technical Analysis
Carol L. Osler

This paper provides a microstructural explanation
for two key predictions of technical analysis: trends
tend to be reversed at predictable support and resistance levels, and trends gain momentum once these
levels are crossed. The explanation is based on an
analysis of stop-loss and take-profit orders at a large
foreign exchange dealing bank—the first foreign
exchange data of their kind available to academic
research. The orders’ requested execution rates are
found to be strongly clustered at round numbers,
which are often used as support and resistance levels.
The marked differences between the clustering patterns of stop-loss and take-profit orders, and between
the patterns of stop-loss buy and stop-loss sell orders,
explain the success of the two predictions.
No. 127

Border Effects and the Availability
of Domestic Products Abroad
Carolyn L. Evans

Borders have a sizable negative impact on trade flows.
This “border effect” could have two explanations: less
international than domestic trade in the goods actually exchanged between countries (“flow”), or
differences between the sets of goods traded internationally and domestically (“availability”). This paper
provides a theoretical and empirical examination of
the distinction between these explanations. The
results suggest that a portion of the border effect is
indeed due to differences between the set of goods
available domestically and internationally. On average
across industries, about half of the effect is due to
flows, while the remainder may be due to availability.

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No. 128

Home Bias in Trade: Location
or Foreign-ness?
Carolyn L. Evans

This paper probes the causes of home bias, in which
consumers generally elect to purchase domestic
goods over imports. The author questions whether
this phenomenon arises from pure locational factors,
such as tariffs or access to a local distribution network, or an inherent preference for domestic goods.
The apparent tendency toward home bias is found to
arise almost entirely from locational factors.
Moreover, if a firm establishes and sells from a foreign subsidiary, its local sales are found to be nearly
on a par with those of domestic firms in that market.
“Foreign-ness” per se does not appear to impact purchases of imported goods.

Banking and Finance
No. 123

How Do Stock Repurchases Affect Bank
Holding Company Performance?
Beverly Hirtle

The author examines the relationship between stock
repurchases and financial performance for a large
sample of bank holding companies from 1987 to
1998. Higher levels of repurchases in one year are
found to be associated with higher profitability and a
lower share of problem loans in the subsequent year.
This result appears to be driven primarily by banks
with publicly traded stock, especially stock traded on
major exchanges. The study also suggests that the
repurchase-performance link is driven by different
factors for different types of banks. In particular, the
evidence is consistent with one hypothesis for banks
traded on major exchanges: bank managers may opt
to return excess funds to shareholders when they
have limited outside investment opportunities.

No. 129

Bank Integration and Business Volatility
Donald Morgan, Bertrand Rime,
and Philip Strahan

The authors investigate how bank migration across
state lines over the past quarter-century has affected
the size and covariance of business fluctuations within states. They conclude that the theoretical effect of
integration on business cycle size is ambiguous
because some shocks are dampened by integration
while others are amplified. Empirically, integration is
found to diminish employment growth fluctuations
within states and to decrease deviations in growth
across them. In other words, business cycles within
states become smaller with integration, but more
alike. The results for the United States bear on the
financial convergence under way in Europe, where
banks remain highly fragmented across nations.
No. 130

Idiosyncratic Risk and Volatility Bounds,
or Can Models with Idiosyncratic Risk
Solve the Equity Premium Puzzle?
Martin Lettau

This paper uses Hansen and Jagannathan’s (1991)
volatility bounds to evaluate models with idiosyncratic consumption risk. It shows that idiosyncratic
risk does not change the volatility bounds when consumers have CRRA preferences and the idiosyncratic
shock distribution is independent of the aggregate
state. Following Mankiw (1986), the author shows
that idiosyncratic risk can help to enter the bounds
when idiosyncratic uncertainty depends on the
aggregate state of the economy. He computes an upper

bound of the volatility bounds using individual
income data and assumes that agents must consume
their endowment. The model does not pass the
Hansen-Jagannathan test, even for very volatile idiosyncratic income data.

Quantitative Methods
No. 132

Markov Switching in Disaggregate
Unemployment Rates
Marcelle Chauvet, Chinhui Juhn,
and Simon Potter

The authors develop a dynamic factor model with
Markov switching to examine secular and business
cycle fluctuations in U.S. unemployment rates. In the
model, they extract the common dynamics among
unemployment rates disaggregated for seven age
groups. This framework allows the authors to analyze
the contribution of demographic factors to secular
changes in unemployment rates as well as the separate contribution of changes due to asymmetric
business cycle fluctuations. The study finds strong
evidence in favor of the common factor and the
switching between high and low unemployment rate
regimes. In addition, demographic adjustments are
found to account for much of the secular change in
the unemployment rate, particularly the abrupt
increase in the 1970s and 1980s and the subsequent
decrease.

Ot her New Publicat ions
• 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
summer issue reports on the recent conference “The Untapped Urban Market: Attracting
Business to the Inner City.” The sessions, cosponsored by the Buffalo Branch, examined
the economic challenges facing inner-city communities and explored strategies for
business development.
www.newyorkfed.org/rmaghome/regional/newsletter.html

www.ne wyorkfed.org/r maghome

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Federal Reser ve Bank of Ne w York

Papers Presented by Economists in the Research
and Market Analysis Group
Commentary on “A Regulatory Regime for Financial
Stability,” by David T. Llewellyn, Arturo Estrella.
Oesterreichische Nationalbank Twenty-Ninth Economics Conference,Vienna,Austria, May 31.
“The Cyclical Behavior of Optimal Bank Capital,”
Arturo Estrella. European Central Bank, Invited
Speakers Program, Frankfurt, Germany. Also presented at Workshop on Applied Banking Research, Norges
Bank, Oslo, June 12.
“Financial Market Implications of the Federal Debt
Paydown,” Michael Fleming. Asset and Liability
Managers Association Annual Meeting, Williamsburg,
Virginia, May 3. Also presented at ABN AMRO Global
Central Bankers Conference,Amsterdam, June 19.
“Does Foreign Ownership Contribute to Sounder Banks
in Emerging Markets? The Latin American Experience,”
Linda Goldberg. World Bank, International Monetary
Fund, and Brookings Institution Conference on Foreign
Participation in Financial Systems in Developing
Countries, New York City, April 21. With B. Gerard
Dages and Jennifer Crystal.
“Exchange Rates and Wages,” Linda Goldberg and
Joseph Tracy. National Bureau of Economic Research
Universities Research Conference on Labor in the Global Economy, Cambridge, Massachusetts, May 11.
“Local Revenue Hills,” Andrew Haughwout. University
of Illinois-Chicago Department of Economics Seminar,
Chicago, Illinois, June 6. With Robert Inman, Steven
Craig, and Thomas Luce.
“Time-Varying Risk Premia and the Cost of Capital,”
Martin Lettau and Sydney Ludvigson. CarnegieRochester Conference Series on Public Policy,
University of Rochester, Rochester, New York,April 20.

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“International Dimensions of Optimal Monetary
Policy,” Paolo Pesenti. Massachusetts Institute of
Technology Department of Economics Seminar,
Cambridge, Massachusetts, May 10. With Giancarlo
Corsetti. Also presented at the University of
Copenhagen, March 30; the University of Aarhus,
Denmark, April 5; INSEAD, Paris, April 9; and New
York University, April 24.
“New and Old Economics in the ‘New Economy,’”Kevin
Stiroh. Kiel Institute of World Economics, Kiel,
Germany, May 15.
“Are ICT Spillovers Driving the New Economy?” Kevin
Stiroh. Canadian Economics Association Annual
Meeting, Montreal, Canada, June 1.
“Information and the U.S. Productivity Revival: What
Do the Industry Data Say?” Kevin Stiroh. ZEW (Centre
for European Economic Research) Conference on
Information and Communication Technologies,
Mannheim, Germany, June 18. Also presented at the
Bank of Italy, Rome, June 19.
“On the Distributional Effects of Exchange Rate
Fluctuations,” Cédric Tille. Swiss Society of Economics
and Statistics Workshop on International Economics,
University of Bern, Bern, Switzerland, June 19.
“Can Vertical Specialization Explain the Growth of
World Trade?”Kei-Mu Yi.Pennsylvania State University
Department of Economics Seminar, University Park,
Pennsylvania, March 30.

Recently Published
Linda Goldberg and Joseph Tracy. 2001. “Gender
Differences in the Labor Market Effects of the Dollar.”
American Economic Review 91, no. 2 (May): 400-5.
Papers and Proceedings of the 113th Annual Meeting
of the American Economic Association.
Andrew Haughwout.2001.“Fiscal Policy in Open Cities
with Firms and Households,” with Robert Inman.
Regional Science and Urban Economics 31: 147-80.
Kenneth Kuttner. 2001. “Monetary Policy Surprises
and Interest Rates: Evidence from the Fed Funds
Futures Market.” Journal of Monetary Economics 47,
no. 3 (June): 523-44.
Martin Lettau. 2001. “Have Individual Stocks Become
More Volatile? An Empirical Exploration of
Idiosyncratic Risk,” with John Campbell, Burton
Malkiel, and Yexiao Xu. Journal of Finance 56, no. 1
(February): 1-43.
Martin Lettau. 2001. “Statistical Estimation and
Moment Evaluation of a Stochastic Growth Model with
Asset Market Restrictions,” with Gang Gong and Willi
Semmler. Journal of Economic Behavior and
Organization 44, no. 1: 85-103.
Martin Lettau and Sydney Ludvigson. 2001.
“Consumption, Aggregate Wealth, and Expected Stock
Returns.” Journal of Finance 56, no. 3 (June): 815-49.
Sydney Ludvigson. 2001. “Approximation Bias in
Linearized Euler Equations,” with Christina Paxson.
Review of Economics and Statistics 83, no. 2: 242-56.
Paolo Pesenti. 2001. “Welfare and Macroeconomic
Interdependence,” with Giancarlo Corsetti. Quarterly
Journal of Economics 116, no. 2 (May): 421-46.
Paolo Pesenti. 2001. Discussion of “Multiple Equilibria,
Contagion, and the Emerging Market Crises,” by Paul
Masson. In Reuven Glick, Ramon Moreno, and Mark
Spiegel, eds., Financial Crises in Emerging Markets,
99-105. Cambridge: Cambridge University Press.

Chris Stefanadis. 2001. “The Emergence of On-Line
Discount Brokers.” New York University Stern
Business (spring/summer): 18-23.
Chris Stefanadis. 2001. “Tying, Investment, and the
Dynamic Leverage Theory,” with Jay Pil Choi. Rand
Journal of Economics 32, no. 1 (spring): 52-71.
Kevin Stiroh. 2001. “ICT Productivity Revival.”
Economic Trends 1: 67-71.
Kevin Stiroh. 2001. “The Impact of Vintage and
Survival on Productivity: Evidence from Cohorts of
U.S. Manufacturing Plants,” with J. Bradford Jensen
and Robert H. McGuckin. Review of Economics and
Statistics 83, no. 2 (May): 323-32.
Kevin Stiroh. 2001.“Is IT Driving the U.S. Productivity
Revival?” International Productivity Monitor 2
(spring): 31-6.
Eric van Wincoop. 2001.“National Money as a Barrier
to International Trade: The Real Case for Currency
Union,” with Andrew K. Rose. American Economic
Review 91, no. 2 (May): 386-90. Papers and
Proceedings of the 113th Annual Meeting of the
American Economic Association.
Kei-Mu Yi.2001.“Can World Real Interest Rates Explain
Business Cycles in a Small Open Economy?” with
William Blankenau and M. Ayhan Kose. Journal of
Economic Dynamics and Control 25 (June/July):867-89.
Kei-Mu Yi. 2001. “International Trade and Business
Cycles: Is Vertical Specialization the Missing Link?”
with M.Ayhan Kose. American Economic Review 91,
no. 2 (May): 371-5. Papers and Proceedings of the
113th Annual Meeting of the American Economic
Association.
Kei-Mu Yi. 2001. “The Nature and Growth of Vertical
Specialization in World Trade,” with David Hummels
and Jun Ishii. Journal of International Economics 54
(June): 75-96.

João Santos. 2001.“The Regulation of Bank Capital: A
Review of the Theoretical Literature.” Financial
Markets,Institutions,and Instruments 10,no.2: 41-84.

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Federal Reser ve Bank of Ne w York

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

No. 124
International Dimensions of Optimal
Monetary Policy
Giancarlo Corsetti and Paolo Pesenti

Economic Policy Review,
Forthcoming

No. 125
Currency Orders and Exchange-Rate Dynamics:
Explaining the Success of Technical Analysis
Carol L. Osler

Boards of Directors as an Endogenously
Determined Institution: A Survey of the
Economic Literature
Benjamin E. Hermalin and Michael S.Weisbach
A Survey of Blockholders and Corporate Control
Clifford G. Holderness

Current Issues in Economics
and Finance, Vol. 7
No. 4
Stocks in the Household Portfolio: A Look Back
at the 1990s
Joseph Tracy and Henry Schneider
No. 5
Curbing Unemployment in Europe: Are There
Lessons from Ireland and the Netherlands?
Cédric Tille and Kei-Mu Yi
No. 6
Investing in Information Technology:
Productivity Payoffs for U.S. Industries
Kevin J. Stiroh

Staff Reports
Available only at our web site.
No. 121
Gender Differences in the Labor Market Effects
of the Dollar
Linda Goldberg and Joseph Tracy
No. 122
Productivity: What Is It, and Why Do We Care
about It?
Charles Steindel and Kevin J. Stiroh
No. 123
How Do Stock Repurchases Affect Bank Holding
Company Performance?
Beverly Hirtle

No. 126
Recent Changes in the U.S. Business Cycle
Marcelle Chauvet and Simon Potter
No. 127
Border Effects and the Availability of Domestic
Products Abroad
Carolyn L. Evans
No. 128
Home Bias in Trade: Location or Foreign-ness?
Carolyn L. Evans
No. 129
Bank Integration and Business Volatility
Donald Morgan, Bertrand Rime,
and Philip Strahan
No. 130
Idiosyncratic Risk and Volatility Bounds,
or Can Models with Idiosyncratic Risk
Solve the Equity Premium Puzzle?
Martin Lettau
No. 131
A Primer on the Economics and Time Series
Econometrics of Wealth Effects: A Comment
Martin Lettau, Sydney Ludvigson,
and Nathan Barczi
No. 132
Markov Switching in Disaggregate
Unemployment Rates
Marcelle Chauvet, Chinhui Juhn,
and Simon Potter

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.