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F e d e r a l R e s e r v e B a n k o f N e w Yo r k

Number 2

2006

ResearchUpdate
Research and Statistics Group

www.newyorkfed.org/research

Mark Gertler Becomes Newest Resident Scholar

T

he Research Group welcomes Mark
Gertler to its Program for Resident
Scholars for 2006-07.
Professor Gertler, the Henry and Lucy
Moses Professor of Economics at NYU
and Chair of the Economics Department,
is known for his research on macroeconomic theory, monetary economics, and
finance. He has published extensively,
coauthoring with Ben Bernanke, Glenn
Hubbard, and Mark Watson, and his work
has appeared in the American Economic
Review, the Journal of Political Economy,
the Quarterly Journal of Economics, and
the Review of Economic Studies.
Professor Gertler has a distinguished
career in academia. He is also a coeditor
of the American Economic Review and
has been on the editorial boards of the
Journal of Money, Credit, and Banking;
Economics Letters; the NBER
Macroeconomics Annual; and the Journal
of Financial Intermediation. In addition,
he is a Fellow of the Econometric Society

and has been a visiting scholar at the
Federal Reserve Bank of New York on
and off since 1994.
Professor Gertler joins current resident
scholars Nobuhiro Kiyotaki of the London
School of Economics and Suresh M.
Sundaresan of Columbia Business School.
The Research Group established its
Program for Resident Scholars in 2004
to attract to the New York Fed, for a stay
of at least six months, outstanding
researchers with an international reputation. The scholars are selected from the
top academic and policy institutions in
areas related to the Bank’s broad policy
interests. Resident scholars pursue their
own research agendas while participating
fully in the Group’s activities. They work
closely with the director of research, contribute to policymaking discussions, and
provide intellectual leadership by advising
and collaborating with the Group’s
economists. ■

Research Update

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Number 2, 2006

Economic Policy Review Sheds Light on Bank Market Size,
Repo Contracting Conventions

S

2

tudies of the banking and repo markets highlight the new issue of the
Economic Policy Review (vol. 12,
no. 1).
In “Local or State? Evidence on Bank
Market Size Using Branch Prices,”
Don Morgan and Paul Edelstein argue
that bank branch prices—the amount one
bank pays to buy another bank’s branches—
may be a better indicator of market size
than bank deposit rates and other
measures.
Morgan and Edelstein explain that
since the 1960s, each Federal Reserve
Bank has defined the markets in its
District as local, that is, metropolitan statistical areas or small groups of rural
counties. However, because banks are
now free to branch all over a state, the
local concept of banking markets may be
outdated—perhaps banking markets are

more statewide than local? Getting the
definition right matters a lot in terms of
how the government enforces antitrust
policy; bank mergers that might appear
anticompetitive under the local market
concept might seem less worrisome if
markets are viewed as statewide.
Using prices on 110 branch sales over
the 1990s, the authors run a “horse
race” to determine which measure
of bank concentration—state or
local—explains more of the variation in
branch prices. They find that prices in
the ten northeast states analyzed are
more closely correlated with state-level
concentration, suggesting that banking
markets, at least in the northeast, are not
necessarily local.
Still, Morgan and Edelstein caution
that their finding may be based on an
arguably small sample of banks as well as

Publications and Papers
The Research and Statistics 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—online 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.

■

Staff Reports—technical papers intended for publication in leading economic
and finance journals, available only online.

■

Publications and Other Research—an annual catalogue of our research output.

F e d e r a l R e s e r v e B a n k o f N e w Yo r k

www.newyorkfed.org/research

on how the data are parsed. “Branch
price data certainly advance the localversus-state debate,” they note. “With
enough such data, that question might be
settled once and for all.”
In his study of the repo market,
Ken Garbade considers how contracting
conventions for repurchase agreements changed in one key decade
(“The Evolution of Repo Contracting
Conventions in the 1980s”).
The author describes how the growth
of the market, new uses for repos, and
the appearance of previously unappreciated
risks fueled dramatic changes in the conventions. In the 1950s and 1960s, dealers
used repos to borrow money; in the
1970s, they engaged in more complex
repo operations, also borrowing securities
to cover short selling and thus adding
risk to the market. Moreover, rising interest rates and growing Treasury indebtedness attracted many new, smaller, and
less sophisticated creditors to the market.
Given these changes, “contracting conventions that were not inefficient in the
context of the repo markets of the 1950s
and 1960s—including neglect of accrued
interest, ambiguity about whether repos
were loans or transactions, and relatively
costly mechanisms for removing repo
securities from the control of
borrowers—proved inadequate by the
early 1980s,” observes Garbade. Market

participants were thus spurred to revise
the conventions dramatically.
The study points to three key developments in the evolution of repo contracting conventions attributable to market
participants’ actions: the recognition of
accrued interest on repo securities, a
revision to how federal bankruptcy law
applied to repos, and the accelerated
growth of tri-party repo—a new form of
repo.
According to the author, market participants acted together to bring about the
recognition of accrued interest on repo
securities and to petition Congress to
amend federal bankruptcy law. Collective
action was necessary in both cases
because uncoordinated, individual solutions would have been too costly. The
emergence of tri-party repo reflected the
efforts of individual market participants
to seek an operationally cheaper, more
flexible alternative to conventional repos.
In the volume’s lead article, John
Kambhu analyzes how the risk associated
with convergence trading affects market
liquidity and asset price volatility in the
interest rate swap market. (This paper
was summarized in the previous issue of
Research Update.)
The articles are available at
www.newyorkfed.org/research/epr/
index.html.

Research and Statistics Group

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Research Update

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Number 2, 2006

New Publication Focuses on the Upstate New York Economy

T
4

he New York Fed’s Buffalo Branch
recently published the first issue of
Upstate New York Regional
Review, a newsletter reporting on topics
of importance to the upstate economy.
In “Baby-Boomer Retirements and
Emerging Labor Market Pressures,”
Richard Deitz studies the demand for
new workers in upstate New York created
by the combination of retirements and
the region’s economic restructuring. His
analysis of projected hiring rates upstate
suggests that although there will be
demand for workers in all occupations in

the coming years, employers may face a
particular challenge filling positions in
growing services occupations with relatively high retirement rates, such as
health care, community and social
services, and education.
Upstate New York Regional Review
is an expanded and more comprehensive
version of its predecessor publication, The
Regional Economy of Upstate New York.
Copies are available at www.newyorkfed.org/
buffalo.

Recently Published
Adam Ashcraft. 2006. “New Evidence on
the Lending Channel.” Journal of Money,
Credit, and Banking 38, no. 3 (April): 751-76.
Gauti Eggertsson. 2006. “The Deflation
Bias and Committing to Being
Irresponsible.” Journal of Money, Credit,
and Banking 38, no. 2 (March): 283-322.
James Harrigan. 2006. “Timeliness and
Agglomeration,” with Anthony J. Venables.
Journal of Urban Economics 59, no. 2
(March): 300-16.
João Santos. 2006. “The American
Keiretsu and Universal Banks: Investing,
Voting, and Sitting on Nonfinancials’
Corporate Boards,” with Adrienne S.
Rumble. Journal of Financial Economics 80,
no. 2 (May): 419-54.

F e d e r a l R e s e r v e B a n k o f N e w Yo r k

João Santos. 2006. “Identifying the Effect
of Managerial Control on Firm
Performance,” with Renée B. Adams.
Journal of Accounting and Economics 41,
no. 1-2 (April): 55-85.
João Santos. 2006. “Insuring Banks
against Liquidity Shocks: The Role of
Deposit Insurance and Lending of Last
Resort.” Journal of Economic Surveys 20,
no. 3 (July): 459-82.
Cédric Tille. 2006. “Current Account
Adjustment with High Financial
Integration: A Scenario Analysis,” with
Michele Cavallo. Federal Reserve Bank of
San Francisco Economic Review 2006:
31-45. ■

www.newyorkfed.org/research

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

MACROECONOMICS
AND GROWTH
No. 245, April 2006
Volatility Accounting: A Production
Perspective on Increased
Economic Stability
Kevin J. Stiroh
Stiroh examines the declining volatility of
U.S. output growth from a production perspective. At the aggregate level, increased
output stability reflects decreased volatility
in both labor productivity growth and
hours growth as well as a significant
decline in the correlation. The decline in
output volatility can also be traced to less
volatile labor input and total factor productivity growth and the smaller covariance
between them. At the industry level, the
decline in volatility appears widespread,
with about 80 percent of component
industries showing smaller contributions to
aggregate output volatility after 1984,
although most of the aggregate decline
reflects smaller covariances between industries. These results suggest that labor market changes are an important source of
increased output stability.

INTERNATIONAL
No. 247, April 2006
Distribution Margins, Imported
Inputs, and the Sensitivity of
the CPI to Exchange Rates
José Manuel Campa and Linda S. Goldberg
This paper decomposes the sources of consumer price index stability for twenty-one
countries, focusing on the important role
that the distribution sector and imported

inputs play in determining the degree to
which exchange rate fluctuations are transmitted to consumption prices. While the
distribution sector dampens the sensitivity
of consumption prices of tradable goods to
exchange rates by reducing the import
content of the final consumption good, it
also enhances sensitivity because the
prices of imported inputs used in the production of distribution services are also
sensitive to exchange rates. Calibration
exercises show that the United States has
the lowest expected CPI sensitivity to
exchange rates—less than 5 percent—
while the cross-country exchange rate
pass-through to CPI averages closer
to 15 percent.
No. 249, April 2006
Expectations and Contagion in
Self-Fulfilling Currency Attacks
Todd Keister
Keister presents a model in which currency
crises can spread across countries as a
result of the self-fulfilling beliefs of market
participants. An incomplete-information
approach is used to overcome many undesirable features of existing multipleequilibrium explanations of contagion.
If speculators expect contagion across
markets to occur, they have an incentive
to trade in both currency markets to take
advantage of this correlation. These
actions, in turn, link the two markets in
such a way that a sharp devaluation of one
currency will be propagated to the other
market, fulfilling the original expectations.
Even though this contagion is driven solely
by expectations, the model places
restrictions on observable variables that
are broadly consistent with existing
empirical evidence.

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Number 2, 2006

No. 250, April 2006
A Decomposition of the Sources of
Incomplete Cross-Border Transmission
Rebecca Hellerstein

6

According to conventional wisdom, relative
price changes are the primary mechanism
by which shocks are transmitted across borders. Yet traded goods prices exhibit significant inertia in response to shocks such as
exchange rate changes. The author uses a
structural model to quantify the relative
importance of manufacturers’ and retailers’
local-cost components and markup adjustments as sources of this incomplete transmission. The model is applied to a panel
data set of one industry with retail and
wholesale prices for Universal Product
Code–level products. Markup adjustments
by manufacturers and retailers explain twothirds of the incomplete transmission, and
local-cost components account for the
remaining third. Foreign manufacturers
generally bear more of the cost (or reap
more of the benefit) of an exchange-rateinduced marginal cost shock than do
domestic consumers, domestic manufacturers, or the domestic retailer.
No. 251, April 2006
Arm’s-Length Transactions as a
Source of Incomplete Cross-Border
Transmission: The Case of Autos
Rebecca Hellerstein
and Sofia Berto Villas-Boas
Hellerstein and Villas-Boas present new
evidence of a positive relationship between
an industry’s share of multinational trade
and its rate of exchange rate pass-through
to prices. They develop a structural econometric model with both manufacturers and
retailers to quantify how firms’ organization
of their activities across borders affects
their pass-through of a foreign cost shock
and apply the model to auto market data.
Firms’ pass-through of foreign cost shocks

F e d e r a l R e s e r v e B a n k o f N e w Yo r k

is on average 29 percentage points lower in
arm’s-length transactions than in multinational transactions because the higher
markups from a double optimization along
the distribution chain create more opportunity for markup adjustment following a
shock. This difference may explain up to
20 percent of the incomplete transmission
of foreign-cost shocks to the United States
in the aggregate.

BANKING AND FINANCE
No. 246, April 2006
Two-Sided Markets and Intertemporal
Trade Clustering: Insights into
Trading Motives
Asani Sarkar and Robert A. Schwartz
Sarkar and Schwartz show that equity markets are typically two-sided and that trades
cluster in certain trading intervals for both
NYSE and Nasdaq stocks under a broad
range of conditions—news and non-news
days, different times of the day, and a spectrum of trade sizes. By “two-sided,” the
authors mean that the arrivals of buyerinitiated and seller-initiated trades are positively correlated; by “trade clustering,” they
mean that trades tend to bunch together in
time with greater frequency than would be
expected if their arrival were a random
process. Controlling for order imbalance,
number of trades, news, and other
microstructure effects, Sarkar and Schwartz
find that two-sided clustering is associated
with higher volatility but lower trading costs.

www.newyorkfed.org/research

No. 248, April 2006
Three Decades of Financial Sector Risk
Joel F. Houston and Kevin J. Stiroh
This study examines the evolution of risk
in the U.S. financial sector using firm-level
equity market data from 1975 to 2005.
Over this period, financial sector volatility
has increased steadily, reaching extraordinary levels from 1998 to 2002. Much of
this recent turbulence can be attributed to
a series of major financial shocks, and
there is evidence of an upward trend in
volatility only for the common sector
component. While idiosyncratic volatility
remains dominant, a combination of common shocks, deregulation, and diversification has reduced its relative importance
since the early 1990s. Within the financial
sector, commercial banks show the largest
rise in volatility, which also reflects industry
shocks and not the idiosyncratic component. Despite these changes, the authors
find that the links between the financial
sector and economic activity have declined
in recent years.

No. 252, May 2006
Visible and Hidden Risk Factors
for Banks
Til Schuermann and Kevin J. Stiroh
Schuermann and Stiroh examine the common factors that drive the returns of U.S.
bank holding companies from 1997 to
2005. They compare a range of market
models and show that the market factor
clearly dominates in explaining bank
returns. Even in the authors’ broadest
model, however, considerable residual variation remains. A principal component
analysis shows that this residual variance is
relatively diffuse, although the largest
banks do tend to load in the same direction
on the first component. Compared with the
returns of large firms in other sectors, bank
returns are relatively well explained with
standard risk factors. This finding assuages
some concerns about systemic risk, but it
does leave open the possibility of systemic
concerns through the “broad channel” if
many banks respond to unexpected shocks
in similar ways. ■

Other New Publications
■

The Federal Reserve Bank of New York’s 2005 Annual Report is available.
www.newyorkfed.org/aboutthefed/annualreports.html

Research and Statistics Group

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Research Update

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Number 2, 2006

Papers Presented by Economists in the Research and Statistics Group

8

“On the Market Discipline of
Informationally Opaque Firms:
Evidence from Bank Borrowers in the
Federal Funds Market,” Adam Ashcraft.
Financial Intermediation Research Society
conference, Shanghai, China, June 3.
With Hoyt Bleakley.

“Dollar Depreciation: Implications for
Exporters, Importers, and the U.S.
Trade Balance,” Linda Goldberg. Seminar
cosponsored by the Buffalo branch of the
Federal Reserve Bank of New York and the
World Trade Center Buffalo Niagara,
Buffalo, New York, June 14.

“Money Market Integration,” Leonardo
Bartolini. Bank of France conference, Paris,
France, June 6.

“The International Role of the Dollar
and Trade Balance Adjustment,” Linda
Goldberg. Conference cosponsored by the
Santa Cruz Center for International
Economics, the Federal Reserve Bank
of San Francisco, and the Center for
European Integration Studies at the
University of Bonn (ZEI), Santa Cruz,
California, May 26. With Cédric Tille.

“Entry into Banking Markets and the
Early-Mover Advantage,” Astrid Dick.
Journal of Financial Intermediation conference, Shanghai, China, June 4. With Allen
Berger. Also presented at a Journal of
Banking and Finance conference, Beijing,
China, June 6.
“Personal Bankruptcy and Credit
Market Competition,” Astrid Dick.
International Industrial Organization
Society conference, Boston, Massachusetts,
April 8. With Andreas Lehnert.
“Monetary Policy Tick-by-Tick,” Michael
Fleming. Bank of Canada conference,
Ottawa, Ontario, Canada, May 3. With
Monika Piazzesi. Also presented at an
NBER conference, Cambridge,
Massachusetts, May 12.
“Distribution Margins, Imported Inputs,
and the Sensitivity of the CPI to
Exchange Rates,” Linda Goldberg. Drexel
University seminar, Philadelphia,
Pennsylvania, May 17.

F e d e r a l R e s e r v e B a n k o f N e w Yo r k

“The Benefits and Challenges of Labor
Mobility,” Erica Groshen. Joint European
Union—United States conference, Brussels,
Belgium, April 10.
“The Interaction of Labor Markets and
Inflation: Analysis of Micro Data from
the International Wage Flexibility
Project,” Erica Groshen. Institute for the
Study of Labor (IZA) seminar, Bonn,
Germany, April 3. With William Dickens,
Lorenz Goette, Steinar Holden, Julian
Messina, Mark Schweitzer, Jarkko Turunen,
and Melanie Ward. Also presented at a
National Bank of Belgium seminar,
Brussels, Belgium, April 5.
“Turbulent Firms, Turbulent Wages?”
Erica Groshen. Society of Labor
Economists conference, Cambridge,
Massachusetts, May 5. With Diego Comin
and Bess Rabin.

www.newyorkfed.org/research

“Arm’s-Length Transactions as a
Source of Incomplete Cross-Border
Transmission,” Rebecca Hellerstein.
NBER Universities’ Research Conference,
Cambridge, Massachusetts, May 19.
“A Framework for Identifying the
Sources of Local-Currency Price
Stability with an Empirical Application:
Some Evidence on the Relative
Importance of Menu Costs, Non-Traded
Local Costs, and Markup Adjustment by
Manufacturers and Retailers,” Rebecca
Hellerstein. New York University
International and Development Economics
seminar, New York City, April 4.
With Pinelopi Goldberg.
“Banking Policy without Commitment:
Suspension of Convertibility Taken
Seriously,” Todd Keister. Rutgers
University Department of Economics
seminar, New Brunswick, New Jersey,
March 7. With Huberto Ennis. Also
presented at the Midwest Macroeconomics
Meetings, Washington University, St. Louis,
Missouri, May 6.
“Expectations and Contagion in SelfFulfilling Currency Attacks,” Todd
Keister. Econometric Society and Allied
Social Sciences Association annual meeting, Boston, Massachusetts, January 7.
Also presented at the Cornell—Penn State
University Macro Workshop, University
Park, Pennsylvania, April 14.
“Housing Activity and Values and
Consumer Spending,” Jonathan McCarthy
and Charles Steindel. Federal Reserve Bank
of Chicago Bank Structure Conference,
Chicago, Illinois, May 18.

“Modeling Global Imbalances and
Current Account Adjustment,” Paolo
Pesenti. European Central Bank seminar,
Frankfurt, Germany, May 3. Also presented
at a European University Institute seminar,
Florence, Italy, May 11.
“The Relationship between Expected
Inflation, Disagreement, and
Uncertainty: Evidence from Matched
Point and Density Forecasts,” Robert
Rich. Midwest Macroeconomics Meetings,
Washington University, St. Louis, Missouri,
May 5. With Joseph Tracy.
“Liquidity Spillovers and CrossAutocorrelations,” Asani Sarkar. Vrije
Universiteit Amsterdam, Amsterdam, the
Netherlands, April 5. With Tarun Chordia
and Avanidhar Subrahmanyam.
“Money and Modern Banking without
Bank Runs,” David Skeie. Financial
Intermediation Research Society
conference, Shanghai, China, June 3.
Also presented at a Journal of Banking
and Finance conference, Beijing,
China, June 6.
“The Industry Origins of the Second
Surge of U.S. Productivity Growth,”
Kevin Stiroh. Conference cosponsored by
the International Telecommunication
Union and the London Business School,
Geneva, Switzerland, June 5.
“The Sources of the Second Surge
of U.S. Productivity Growth and
Implications for the Future,” Kevin
Stiroh. Conference cosponsored by the
Bank of France and the Bank of Canada,
Paris, France, April 24. With Dale W.
Jorgenson and Mun S. Ho.

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Number 2, 2006

“Three Decades of Financial Sector
Risk,” Kevin Stiroh. Conference cosponsored by the Federal Reserve Bank of
Atlanta and the International Association
of Financial Engineers, Atlanta, Georgia,
April 18. With Joel Houston. Also presented
at a Swiss National Bank conference,
Zurich, Switzerland, May 31, and the
International Monetary Fund, Washington,
D.C., June 13.

10

“Intertemporal Disturbances,” Andrea
Tambalotti. Conference cosponsored by the
University of Quebec at Montreal and the
Interuniversity Center on Risk, Economic
Policy, and Employment (CIRPEE),
Montreal, Quebec, Canada, June 5.
With Giorgio Primiceri and Ernst
Schaumburg.

“Could Capital Gains Smooth a Current
Account Rebalancing?” Cédric Tille.
University of Wisconsin seminar, Madison,
Wisconsin, April 28. With Michele Cavallo.
“Financial Integration and the Wealth
Effect of Exchange Rate Fluctuations,”
Cédric Tille. Conference cosponsored by
the Santa Cruz Center for International
Economics, the Federal Reserve Bank
of San Francisco, and the Center for
European Integration Studies at the
University of Bonn (ZEI), Santa Cruz,
California, May 27.
“Catastrophe Bonds, Reinsurance, and
the Optimal Collateralization of Risk
Transfer,” George Zanjani. Risk Theory
Society Annual Seminar, Richmond,
Virginia, April 22. With Darius Lakdawalla. ■

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Visit www.newyorkfed.org/alertservices/ and select “Research Alert.”

F e d e r a l R e s e r v e B a n k o f N e w Yo r k

www.newyorkfed.org/research

Research and Statistics Group
Publications and Papers:
April-June 2006
Publications are available at
www.newyorkfed.org/research/
publication_annuals/index.html.

ECONOMIC POLICY REVIEW,
VOL. 12

STAFF REPORTS
No. 245, April 2006
Volatility Accounting: A Production
Perspective on Increased
Economic Stability
Kevin J. Stiroh
No. 246, April 2006
Two-Sided Markets and Intertemporal
Trade Clustering: Insights into
Trading Motives
Asani Sarkar and Robert A. Schwartz

No. 1, May 2006
Trading Risk, Market Liquidity, and
Convergence Trading in the Interest
Rate Swap Spread
John Kambhu

No. 247, April 2006
Distribution Margins, Imported
Inputs, and the Sensitivity of
the CPI to Exchange Rates
José Manuel Campa and Linda S. Goldberg

Local or State? Evidence on Bank
Market Size Using Branch Prices
Paul Edelstein and Donald P. Morgan

No. 248, April 2006
Three Decades of Financial Sector Risk
Joel F. Houston and Kevin J. Stiroh

The Evolution of Repo Contracting
Conventions in the 1980s
Kenneth D. Garbade

No. 249, April 2006
Expectations and Contagion in
Self-Fulfilling Currency Attacks
Todd Keister

CURRENT ISSUES IN ECONOMICS
AND FINANCE, VOL. 12

No. 250, April 2006
A Decomposition of the Sources of
Incomplete Cross-Border Transmission
Rebecca Hellerstein

No. 3, April 2006
Alternative Arrangements for the
Distribution of Intraday Liquidity
James J. McAndrews
No. 4, May/June 2006
Taking the Pulse of the
NewYork City Economy
Jason Bram and James Orr
Second District Highlights

No. 251, April 2006
Arm’s-Length Transactions as a
Source of Incomplete Cross-Border
Transmission: The Case of Autos
Rebecca Hellerstein
and Sofia Berto Villas-Boas
No. 252, May 2006
Visible and Hidden Risk Factors
for Banks
Til Schuermann and Kevin J. Stiroh

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 Statistics Group

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