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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 3

2008

ResearchUpdate
Research and Statistics Group

www.newyorkfed.org/research

John Leahy Joins Research Group’s Resident Scholars Program

J

ohn Leahy has become a resident
The Research Group established its
scholar of the Research Group
Program for Resident Scholars in 2004
through the end of 2008. He joins
to attract to the New York Fed, for a stay
Eric Ghysels, resident scholar for
of at least six months, outstanding
2008-09.
researchers with an international reputaProfessor Leahy is a professor of ecotion. The scholars are selected from the
nomics at New York University. He has
top academic and policy institutions in
also held teaching positions at Boston
areas related to the Bank’s broad policy
University and Harvard University and
interests. Resident scholars pursue their
served as a visiting scholar at the Federal
own research agendas while participatReserve Banks of Kansas City, New York,
ing fully in the Group’s activities. They
and Philadelphia. Professor Leahy is wellwork closely with the director of
known for his research on macroeconomics,
research, contribute to policymaking
economic theory, and behavioral economics.
discussions, and provide intellectual
His work has appeared in the American
leadership by advising and collaborating
Economic Review, the Journal of Political
with the Group’s economists.
Economy, the Quarterly Journal
of Economics, and the Review
of Economics and Statistics.
Also in this issue…
He is an associate editor of
Economic Policy Review examines payment activities
the American Economic
from eight diverse perspectives . . . . . . . . . . . . . . . . . . 2
Review and the Review of
New lending facility is designed to improve liquidity
Economics and Statistics.
conditions in the interbank funding markets. . . . . . . 4
In addition, Professor Leahy
Other new publications . . . . . . . . . . . . . . . . . . . . . . . . . . 5
is a research associate at
Website features most downloaded publications . . . . . . 6
the National Bureau of
Staff Reports: New titles . . . . . . . . . . . . . . . . . . . . . . . . . 7
Economic Research and
Papers recently published by Research Group
was a research fellow of the
economists. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Alfred P. Sloan Foundation.
Papers presented at conferences . . . . . . . . . . . . . . . . . . 13
Publications and papers: July-September. . . . . . . . . . . 15

RV oe ls ue ma rec h9 , U Np du amtbee r■ 4N, u 2m0b0e 6r 3 , 2 0 0 8

Previous resident scholars are Mark
Gertler, the Henry and Lucy Moses
Professor of Economics at New York
University; Nobuhiro Kiyotaki, professor
of economics at Princeton University;
Suresh M. Sundaresan, the Chase

Manhattan Bank Foundation Professor
of Financial Institutions at Columbia
Business School; and Jiang Wang, the
Mizuho Financial Group Professor at
MIT’s Sloan School of Management. ■

Economic Policy Review Examines Economics of Payments
from Eight Diverse Perspectives
2

A

s sthe
theglobal
globaleconomy
economycontinues
continuestoto
grow,
grow, payments
payments have
have increased
increased in
in
importance as a component of
financial services—and their contribution
to the economy is likely to rise as well.
This rising trend is especially relevant for
banks and central banks as providers of
payment services. Bank customers often
rely on credit provided by their institutions to complete payments, while banks
themselves depend on very short-term
credit supplied by central banks to make
payments. Managing payments is therefore part of a larger risk management
process in the financial sector because
financial institutions providing credit
must manage risk to prevent excessive
exposure.
These developments are transforming
the economics of payments into a rapidly
growing area of research. In September
2008, the New York Fed published a special issue of the Economic Policy Review
(vol. 14, no. 2) to deepen interest in this
dynamic field as well as to spur further
work on behavior in payments systems.
The eight studies collected center on
three broad themes: theoretical models of
money and payments, empirical analyses

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

of trends in large-value payments, and
risk management in payments systems.
The variety of approaches and techniques
they employ illustrate the diversity of
interests that economists are bringing to
the study of payment activities.
The theoretical theme is examined in
three articles. Two—“Intraday Liquidity
Management: A Tale of Games Banks
Play,” by Morten L. Bech, and “An
Economic Analysis of Liquidity-Saving
Mechanisms,” by Antoine Martin and
James McAndrews—emphasize largevalue payments systems. The authors
explore banks’ strategic incentives to
submit payments on time in different
economic environments. They consider
how the incentives are affected by different central bank policies, such as the
terms under which intraday credit is
provided. In the third article, “Divorcing
Money from Monetary Policy,” Todd
Keister, Antoine Martin, and James
McAndrews evaluate alternative models
of monetary policy implementation.
This study also considers the relationship between the demand for intraday
balances to meet payment needs and
the reserve balances used by monetary

www.newyorkfed.org/research

authorities to accomplish their policy
objectives.
Morten L. Bech, Christine Preisig, and
Kimmo Soramäki bring an empirical perspective to developments in large-value
payments over the past decade. Their
contribution, “Global Trends in LargeValue Payments,” points to ten major
trends in the growth and evolution of
payments, as well as three key drivers of
the trends: technological innovation,
structural changes in banking, and the
evolution of central bank policies. The
timing of large-value payments systems is
considered by two additional empirical
studies—“Changes in the Timing
Distribution of Fedwire Funds Transfers”
and “The Timing and Funding of CHAPS
Sterling Payments.” Both articles complement Bech’s theoretical work by
explaining how different central bank
policies influence payment timing. The
first, by Olivier Armantier, Jeffrey Arnold,
and James McAndrews, focuses on
Fedwire, the Federal Reserve’s system;

the second, by Christopher Becher,
Marco Galbiati, and Merxe Tudela,
examines CHAPS, the major U.K. system.
The differences in payment timing
between the two systems are found to
be significant.
The volume’s final two papers consider
the theme of risk management, applying
the economic reasoning associated with
risks in credit arrangements to the specific
case of payments. “Understanding Risk
Management in Emerging Retail
Payments,” by Michele Braun, James
McAndrews, William Roberds, and
Richard Sullivan, emphasizes emerging
retail systems while “An Economic
Perspective on the Enforcement of Credit
Arrangements: The Case of Daylight
Overdrafts in Fedwire,” by Antoine Martin
and David C. Mills, focuses on the risk
associated with central bank intraday
lending to banks.
The articles are available at
www.newyorkfed.org/research/epr/
index.html.

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.

Research and Statistics Group

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Research Update

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Number 3, 2008

New Lending Facility Is Designed to Improve Liquidity Conditions
in the Interbank Funding Markets

I

4

n response to ongoing pressure on
term funding rates in the interbank
funding markets, in December 2007
the Federal Reserve began auctioning
funds directly to depository institutions.
By introducing the Term Auction Facility
(TAF), the Fed sought to improve liquidity
conditions in a key funding environment,
observe Olivier Armantier, Sandra Krieger,
and James McAndrews, authors of “The
Federal Reserve’s Term Auction Facility”
(Current Issues in Economics and Finance,
July 2008).
Their study explains that when the
interbank funding markets run smoothly,
primary dealers (banks and brokers that
trade U.S. government and other securities with the New York Fed) distribute to
banks reserves provided by the Federal
Reserve, facilitating
In December 2007, transactions in the
the Federal Reserve larger economy. Banks
in turn base their willintroduced the ingness to lend to one
Term Auction Facility another on their creditto auction funds worthiness and on their
directly to banks. own ability to access
the funding markets.
During crisis periods, however, a sudden
reduction in that willingness or ability
disrupts the markets and financial intermediation more broadly.
Crisis conditions began to emerge in
the interbank funding markets in the late
summer of 2007, following deteriorating
performance in much of the market for
mortgage-backed securities. Interest rate
premiums on unsecured bank funding for

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

one month or longer rose dramatically
while the volume of unsecured term
(longer than overnight) funding contracted.
The persistence of high term rates kept
interest rates elevated on a range of
instruments, such as home mortgages and
corporate loans. Moreover, an increasing
dependence on overnight borrowing contributed to higher volatility in overnight
interest rates, subjecting banks to greater
uncertainty about funding costs. Thus,
the short-term money markets were not
operating efficiently.
To inject more liquidity into the interbank funding markets, in August 2007
the Fed made several changes to its
discount window, a backstop source of
liquidity used by banks mainly during
market disruptions. However, the changes
generated little additional borrowing. As
strain on term funding rates persisted
into the fall, the central bank devised
another way to provide liquidity to the
markets.
In December 2007, the Federal
Reserve introduced the Term Auction
Facility to auction funds directly to banks.
Sound institutions, note the authors,
can use the TAF to obtain longer term
funding on a collateralized basis through
periodic auctions. The facility originates
and distributes lending of fixed amounts
of funds in a fashion similar to the Fed’s
open market operations (through which
the aggregate level of balances available in the banking system, and thus
the federal funds rate, are affected).
At the same time, the TAF lends on a

www.newyorkfed.org/research

collateralized basis by using the discount
window and its collateral management
operations. The facility differs from the
discount window, however, in its use of
a competitive auction format and a
market-determined interest rate.
Armantier, Krieger, and McAndrews
describe the first ten TAF auctions conducted between December 17, 2007,
and April 21, 2008. The first eight
auctions attracted significant bidding
competition for funds. In addition, the
number of participants has generally
been strong—suggesting that many banks
are recognizing the usefulness of the
auctions, according to the study. The new
facility has also been allocating funds at

rates generally consistent with market
rates. These results lead the authors to
conclude that the Term Auction Facility
can be an important tool in mitigating
difficulties in the funding markets.
The article is available at
www.newyorkfed.org/research/current_
issues/ci14-5.html.

Editor’s note: At the end of thirdquarter 2008, the TAF remains an
important tool used by the Fed to
address the market turmoil. More
information on the facility and results
for all auctions can be found at
www.federalreserve.gov/monetarypolicy
/taf.htm.

Other New Publications
■

Facts & Trends—a new Bank publication that presents key facts on issues of
interest to governments, community advocates, institutions, and practitioners in
the Federal Reserve’s Second District. The first set of articles in the series will
have a shared focus on subprime mortgage conditions around the region. The
articles will complement the dynamic maps of nonprime mortgage conditions
currently available on the New York Fed’s website.
The first issue—“A Look at New Jersey’s Subprime Mortgages in Foreclosure”—
traces patterns of regional variation in, and neighborhood concentration of,
owner-occupied subprime mortgages in foreclosure.
The article is available at www.newyorkfed.org/newsevents/news/regional_
outreach/2008/facts_trends.pdf; the maps can be found at www.newyorkfed.org/
mortgagemaps/.

Research and Statistics Group

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Number 3, 2008

Website Features Most Downloaded Publications

V

6

isitors to a newly created web
page can link to the top ten
Research Group articles and
papers downloaded from the New York
Fed’s website as well as from the Bank’s
page on the Social Science Research
Network site.
The web page is designed to showcase
the work of our economists that is most
in demand, to give you a sense of what
others in the field are reading, and to
share some publications of interest that
you may have missed. In fact, articles that
remain among the favorites were often
published several years ago.
In the third quarter, the three most
downloaded articles from our site were:

The three most downloaded articles
from our page on the SSRN site
(www.ssrn.com/link/FRB-New-York
.html) were:
■

“Understanding the Securitization
of Subprime Mortgage Credit,” by
Adam B. Ashcraft and Til Schuermann
(Staff Report no. 318, March 2008) –
2,155 downloads;

■

“The Consolidation of the Financial
Services Industry: Causes, Consequences, and Implications for the
Future,” by Allen N. Berger, Rebecca
S. Demsetz, and Philip E. Strahan
(Staff Report no. 55, December 1998)
– 2,109 downloads;
“An Empirical Analysis of Stock and
Bond Market Liquidity,” by Tarun
Chordia, Asani Sarkar, and Avanidhar
Subrahmanyam (Staff Report no. 164,
March 2003) – 1,728 downloads;

■

“Understanding the Securitization
of Subprime Mortgage Credit,” by
Adam B. Ashcraft and Til Schuermann
(Staff Report no. 318, March 2008) –
4,177 downloads;

■

■

“Divorcing Money from Monetary
Policy,” by Todd Keister, Antoine
Martin, and James McAndrews
(Economic Policy Review 14, no. 2,
September 2008) – 1,899 downloads;

The page will be updated quarterly.
For the full lists of top-ten downloads,
visit www.newyorkfed.org/research/
top_downloaded/index.html.

■

“The Yield Curve as a Predictor of U.S.
Recessions,” by Arturo Estrella and
Frederic S. Mishkin (Current Issues
in Economics and Finance 2, no. 7,
June 1996) – 1,891 downloads.

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

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. 334, July 2008
Interpreting the Great Moderation:
Changes in the Volatility of Economic
Activity at the Macro and Micro Levels
Steven J. Davis and James A. Kahn
Davis and Kahn review evidence on the
Great Moderation together with evidence
on volatility trends at the micro level to
develop a possible explanation for the
decline in aggregate volatility since the
1980s and its consequences. Their explanation stresses improved supply-chain
management, particularly in the durable
goods sector and, less important, a shift in
production and employment from goods to
services. The study provides evidence that
better inventory control made a substantial
contribution to declines in firm-level and
aggregate volatility. Consistent with this
view, if one looks past the turbulent 1970s
and early 1980s, much of the moderation
reflects a decline in high-frequency (shortterm) fluctuations. While these developments represent efficiency gains, they do
not imply (nor is there evidence for) a
reduction in economic uncertainty faced by
individuals and households.

No. 339, July 2008
The Advantage of Flexible Targeting Rules
Andrea Ferrero
This paper investigates the consequences of
debt stabilization for inflation targeting. If
the monetary authority perfectly stabilizes
inflation while the fiscal authority holds

constant the real value of debt at maturity,
the equilibrium dynamics might be indeterminate. However, determinacy can be
restored by committing to targeting rules
for either monetary or fiscal policy that
include a concern for stabilization of the
output gap. In solving the indeterminacy
problem, flexible inflation targeting appears
to be more robust than flexible debt targeting to alternative parameter configurations
and steady-state fiscal stances. If considerations beyond stabilization call for a combination of strict inflation and debt targeting
rules, the indeterminacy result can be
overturned if the fiscal authority commits
to holding constant debt net of interest
rate spending.

No. 342, September 2008
Central Bank Transparency and
Nonlinear Learning Dynamics
Stefano Eusepi
Central bank communication plays an
important role in shaping market participants’ expectations. This paper studies a
simple nonlinear model of monetary policy
in which agents have incomplete information about the economic environment.
It shows that agents’ learning and the
dynamics of the economy are heavily
affected by central bank transparency
about its policy rule. A central bank that
does not communicate its rule can induce
“learning equilibria” in which the economy alternates between periods of deflation
coupled with low output and periods of
high economic activity with excessive
inflation. More generally, initial beliefs
that are arbitrarily close to the inflation
target equilibrium can result in complex
economic dynamics, resulting in welfarereducing fluctuations. On the contrary,
central bank communication of policy
rules helps stabilize expectations around
the inflation target equilibrium.

Research and Statistics Group

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Number 3, 2008

No. 343, September 2008
Stabilizing Expectations under Monetary
and Fiscal Policy Coordination
Stefano Eusepi and Bruce Preston

8

This paper analyzes how the formation of
expectations constrains monetary and fiscal
policy design. When agents are learning
about the policy regime, there is greater
need for policy coordination: the specific
choice of monetary policy limits the set
of fiscal policies consistent with macroeconomic stability—and simple Taylor-type
rules frequently lead to expectations-driven
instability. In contrast, non-Ricardian fiscal
policies combined with an interest rate peg
promote stability. Resolving uncertainty
about the prevailing monetary policy
regime improves stabilization policy,
enlarging the menu of policy options consistent with stability. However, there are
limits to the benefits of communicating the
monetary policy regime: the more heavily
indebted the economy, the greater the likelihood of expectations-driven instability.

No. 345, September 2008
What Drives Housing Prices?
James A. Kahn
Kahn develops a growth model with land,
housing services, and other goods that is
capable of explaining a substantial portion
of the movements in housing prices over
the past forty years. His paper introduces a
Markov regime-switching specification for
productivity growth in the nonhousing sector and uses micro data to calibrate a key
cross-elasticity parameter that governs the
relationship between productivity growth
and home price appreciation. Combined
with a realistic model of learning about the
productivity process, the model is able to
capture the medium- and low-frequency
fluctuations of both price and quantity
from the residential sector. The model suggests that the current downturn in the
housing sector was triggered by a productivity slowdown that may have begun in
2004, an event that could reasonably have

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

been viewed as highly unlikely by investors
and mortgage issuers in the early part of
the decade.

No. 346, September 2008
Financial Intermediaries, Financial
Stability, and Monetary Policy
Tobias Adrian and Hyun Song Shin
In a market-based financial system, banking and capital market developments are
inseparable. Adrian and Shin document
evidence that balance sheets of marketbased financial intermediaries provide a
window on the transmission of monetary
policy through capital market conditions.
Short-term interest rates are determinants
of the cost of leverage and are found to
be important in influencing the size of
financial intermediary balance sheets.
However, except for periods of crises,
higher balance-sheet growth tends to be
followed by lower interest rates, and slower
balance-sheet growth is followed by higher
interest rates. This suggests that consideration might be given to a monetary policy
that anticipates the potential disorderly
unwinding of leverage. In this sense,
monetary policy and financial stability
policies are closely linked.

INTERNATIONAL
No. 333, July 2008
Banking Globalization, Monetary
Transmission, and the Lending Channel
Nicola Cetorelli and Linda S. Goldberg
Using quarterly information from all U.S.
banks filing call reports between 1980 and
2005, Cetorelli and Goldberg find evidence
of a lending channel for monetary policy in
large banks, but only in those banks that
serve the domestic market and have no
international operations. The authors show
that the large banks that operate globally
rely on internal capital markets with their
foreign affiliates to help smooth domestic
liquidity shocks. They also show that the
existence of such internal capital markets

www.newyorkfed.org/research

contributes to an international propagation
of domestic liquidity shocks to lending by
affiliated banks abroad. While these results
indicate a substantially more active lending
channel than is documented in Kashyap
and Stein (2000), they also imply that the
lending channel within the United States is
declining in strength as banking becomes
more globalized.

MICROECONOMICS
No. 332, July 2008
Human Capital and Economic Activity
in Urban America
Jaison R. Abel and Todd M. Gabe
This paper examines the relationship
between human capital and economic
activity in U.S. metropolitan areas, extending the existing literature in two important
ways. First, the authors utilize new data
on metropolitan area GDP to measure
economic activity. Using educational attainment as an indicator of human capital,
they find that a one-percentage-point
increase in the proportion of residents
with a college degree is associated with a
2.3 percent increase in metropolitan area
GDP per capita. Second, Abel and Gabe
move beyond the conventional proxy for
human capital—educational attainment—to
develop new measures that reflect the types
of knowledge within U.S. metropolitan
areas. Their results show that knowledge
associated with the provision of producer
services and information technology are
particularly important determinants of economic vitality in U.S. metropolitan areas.

No. 341, August 2008
Juvenile Delinquent Mortgages:
Bad Credit or Bad Economy?
Andrew Haughwout, Richard Peach,
and Joseph Tracy
Haughwout, Peach, and Tracy study early
defaults among nonprime mortgages from
the 2001 to 2007 vintages. After documenting a dramatic rise in such defaults and

discussing their correlates, they examine
two primary explanations: changes in
underwriting standards that took place over
this period and changes in the economic
environment. The authors find that while
credit standards were an important factor
behind the rising probability of an early
default, changes in the economy after
2004—especially a sharp reversal in house
price appreciation—were the more critical
factor. They also find that despite their rich
set of covariates, much of the increase
remains unexplained, even in retrospect.
This finding helps explain why credit
markets seemed surprised by the sharp
increase in early defaults in the 2006 and
2007 nonprime vintages.

No. 344, September 2008
Have Amenities Become Relatively
More Important than Firm Productivity
Advantages in Metropolitan Areas?
Richard Deitz and Jaison R. Abel
Deitz and Abel analyze patterns of compensating differentials to determine
whether a region’s bundle of site characteristics has a greater net effect on household
location decisions relative to firm location
decisions in U.S. metropolitan areas over
time. The authors estimate skill-adjusted
wages and attribute-adjusted rents for
238 metropolitan areas in 1990 and 2000.
They classify each metropolitan area based
on whether amenities or firm productivity
advantages dominate, and analyze the
extent to which these classifications change
between 1990 and 2000. Deitz and Abel
then decompose compensating differentials
into amenity and firm productivity advantage components and examine how these
components change. Empirical results
suggest that while the relative importance
of amenities appears to have increased
slightly between 1990 and 2000, firm
productivity advantages continued to dominate amenities in the vast majority of
metropolitan areas during this decade.

Research and Statistics Group

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Number 3, 2008

No. 347, September 2008
ESOP Fables: The Impact of Employee
Stock Ownership Plans on Labor Disputes
Peter Cramton, Hamid Mehran,
and Joseph Tracy

10

Cramton, Mehran, and Tracy examine the
implications of employee stock ownership
plans (ESOPs) for collective bargaining or,
more generally, for cross ownership. They
extend the signaling model of Cramton
and Tracy (1992) to allow partial ownership by the union, and they demonstrate
that ESOPs create incentives for unions
to become weaker bargainers. The model
predicts that ESOPs will lead to a reduction in strike incidence and in the fraction
of labor disputes that involve a strike. U.S.
bargaining data from 1970 to 1995 suggest
that ESOPs do increase the efficiency of
labor negotiations by shifting the composition of disputes away from costly strikes.
Consistent with improved bargaining
efficiency, the authors find that the
announcement of a union ESOP leads to
a 50 percent larger stock market reaction
when compared with the announcement
of a nonunion ESOP.

BANKING AND FINANCE
No. 335, July 2008
The Effect of the Term Auction Facility
on the London Inter-Bank Offered Rate
James McAndrews, Asani Sarkar,
and Zhenyu Wang
This paper examines the effects of the
Federal Reserve’s Term Auction Facility
(TAF) on the London Inter-Bank Offered
Rate (LIBOR). The particular question
investigated is whether the announcements
and operations of the TAF are associated
with downward shifts of the LIBOR; such
an association would provide one indication of the TAF’s effectiveness in mitigating
liquidity problems in the interbank funding
market. The study’s empirical results suggest that the TAF has helped to ease
strains in this market.

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

No. 336, July 2008
A Study of Competing Designs for
a Liquidity-Saving Mechanism
Antoine Martin and James McAndrews
Martin and McAndrews study two designs
for a liquidity-saving mechanism (LSM),
a queuing arrangement used as part of an
interbank settlement system. They consider
an environment in which banks must
decide to send, queue, or delay their
payments after observing a noisy signal
of a liquidity shock. With one design—
a balance-reactive LSM—banks can set a
balance threshold below which payments
are not released from the queue. Banks
can choose their threshold in such a way
that the release of a payment from the
queue is conditional on the liquidity shock.
With the second design—a receipt-reactive
LSM—a payment is released from the
queue if an offsetting payment is received,
regardless of the liquidity shock. The
authors find that these two designs have
opposite effects on different types of payments. They also show that parameter
values will determine which design provides
higher welfare.

No. 337, July 2008
Should There Be Intraday Money Markets?
Antoine Martin and James McAndrews
This paper considers the case for an intraday market for reserves. Martin and
McAndrews discuss the separate roles of
intraday and overnight reserves and argue
that an intraday market could be organized
in the same way as the overnight market.
The authors present arguments for and
against a market for intraday reserves when
the marginal cost of overnight reserves is
positive. They also consider how reserves
should be supplied when the cost of
overnight reserves is zero. In that case, the
distinction between overnight and intraday
reserves becomes blurred, raising an
important question: What is the role of the
overnight market?

www.newyorkfed.org/research

No. 338, July 2008
Financial Intermediary Leverage
and Value-at-Risk
Tobias Adrian and Hyun Song Shin
Adrian and Shin study a contracting model
for the determination of leverage and balance sheet size for financial intermediaries
that fund their activities through collateralized borrowing. The model gives rise to
two features: First, leverage is procyclical
in the sense that leverage is high when the
balance sheet is large. Second, leverage
and balance sheet size are both determined
by the riskiness of assets. For U.S. investment banks, the authors find empirical
support for both features of the model—that
is, leverage is procyclical, and both leverage and balance sheet size are determined
by measured risks. In a system context,
increased risk reduces the debt capacity of
the financial system as a whole, giving rise
to amplified de-leveraging by institutions
by way of the chain of repo transactions
in the financial system.

No. 340, August 2008
Pricing the Term Structure
with Linear Regressions
Tobias Adrian and Emanuel Moench
Adrian and Moench develop an affine term
structure model from a conditionally linear
pricing kernel, without making distributional assumptions about shocks. Assuming
pricing factors to be observable, they
estimate the model by way of three-stage
ordinary least squares, which can be inter-

preted as dynamic Fama-MacBeth regressions. The authors derive cross-equation
restrictions for bond yields, which they do
not impose in the estimation, but instead
test. They can easily estimate specifications
with large numbers of pricing factors,
including volatility factors. The authors
uncover specifications that give rise to
lower pricing errors than do commonly
advocated specifications, both in- and outof-sample. Efficiency can be obtained by
way of the generalized method of moments
estimator.

No. 348, September 2008
CoVaR
Tobias Adrian and Markus K. Brunnermeier
Adrian and Brunnermeier define CoVaR as
the value at risk (VaR) of financial institutions conditional on other institutions
being in distress. The increase of CoVaR
relative to VaR measures spillover risk
among institutions. The authors estimate
CoVaR using quantile regressions and document significant CoVaR increases among
financial institutions. They identify six risk
factors that allow institutions to offload tail
risk and show that such hedging reduces
the wedge between CoVaR and VaR. Adrian
and Brunnermeier argue that financial
institutions should report CoVaR in addition to VaR, and they draw implications for
risk management, regulation, and systemic
risk. They define co-expected shortfall as a
sum of CoVaRs. ■

Research and Statistics Group

11

Research Update

■

Number 3, 2008

Recently Published
Gauti Eggertsson. 2008. “Great Expectations
and the End of the Depression.” American
Economic Review 98, no. 4 (September):
1476-1516.

12

Linda Goldberg. 2008. “Pass-Through of
Exchange Rates to Consumption Prices:
What Has Changed and Why?” with José
Manuel Campa. In Takatoshi Ito and
Andrew K. Rose, eds., International
Financial Issues in the Pacific Rim: Global
Imbalances, Financial Liberalization, and
Exchange Rate Policy, 139-76. East Asia
Seminar on Economics 17. NBER conference volume. Chicago: University of
Chicago Press.

Paolo Pesenti. 2008. “Would Protectionism
Defuse Global Imbalances and Spur
Economic Activity? A Scenario Analysis,”
with Hamid Faruqee, Douglas Laxton, and
Dirk Muir. Journal of Economic Dynamics
and Control 32, no. 8 (August): 2651-89.
Ay
Aysegül
,egül Sahin.
,ahin. 2008. “Aggregate Implications of Indivisible Labor, Incomplete
Markets, and Labor Market Frictions,” with
Per Krusell, Toshihiko Mukoyama, and
Richard Rogerson. Journal of Monetary
Economics 55, no. 5 (July): 961-79.
Proceedings of Labor Markets,
Macroeconomic Fluctuations, and
Monetary Policy, Carnegie-Rochester
Conference Series on Public Policy.

Andrew Haughwout, Richard Peach, and
Joseph Tracy. 2008. “Juvenile Delinquent
Mortgages: Bad Credit or Bad Economy?”
Journal of Urban Economics 64, no. 2
(September): 246-57.

João Santos. 2008. “The Decision to First
Enter the Public Bond Market: The Role
of Firm Reputation, Funding Choices,
and Bank Relationships,” with Galina Hale.
Journal of Banking and Finance 32, no. 9
(September): 1928-40.

Rebecca Hellerstein. 2008. “Who Bears
the Cost of a Change in the Exchange
Rate? Pass-Through Accounting for the
Case of Beer.” Journal of International
Economics 76, no. 1 (September): 14-32.

Wilbert van der Klaauw. 2008. “Social
Security and the Retirement and Savings
Behavior of Low-Income Households,”
with Kenneth Wolpin. Journal of
Econometrics 145, no. 1-2 (July): 21-42. ■

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

Papers Presented by Economists in
the Research and Statistics Group
“Financial Intermediary Leverage
and Value at Risk,” Tobias Adrian.
Oesterreichische Nationalbank Research
Workshop on the Economics of Financial
Stability, Vienna, Austria, July 8. With
Hyun Song Shin.

“Credit Frictions and Optimal Monetary
Policy,” Vasco Cúrdia. Banque de France–
CEPREMAP conference on DSGE
Modeling and Monetary Policy, Paris,
France, September 11.
“Optimal Monetary Policy under Sudden
Stops,” Vasco Cúrdia. Society for Economic
Dynamics annual meeting, Cambridge,
Massachusetts, July 12.

“Risk Spillovers of Financial Institutions,”
Tobias Adrian. NBER Summer Institute
Workshop on Risks of Financial Institutions,
Cambridge, Massachusetts, July 10. With
Markus K. Brunnermeier.

“Expectations, Learning, and Business
Cycle Fluctuations,” Stefano Eusepi.
Fourteenth International Conference on
Computing in Economics and Finance,
Paris, France, June 28. With Bruce Preston.

“Pricing the Term Structure with Linear
Regressions,” Tobias Adrian and Emanuel
Moench. Stanford Institute for Theoretical
Economics, Stanford, California, July 26.

“When Does Determinacy Imply Expectational
Stability?” Stefano Eusepi. Society for
Economic Dynamics annual meeting,
Cambridge, Massachusetts, July 10. With
James Bullard.

“Liquidity and Congestion,” Gara Afonso.
Society for Economic Dynamics annual
meeting, Cambridge, Massachusetts, July 11.
Also presented at the Joint European
Meeting of the European Economic
Association and the Econometric Society,
Milan, Italy, August 30.
“Measuring the Impact of Securitization
on Imputed Bank Output,” Adam Ashcraft
and Charles Steindel. NBER Summer
Institute Conference on Research in Income
and Wealth, Cambridge, Massachusetts,
July 15.
“Aggregation and the PPP Puzzle in a
Sticky-Price Model,” Carlos Carvalho.
NBER Summer Institute International
Finance and Macroeconomics Workshop,
Cambridge, Massachusetts, July 7. With
Fernanda Nechio.
“Heterogeneous Price-Setting Behavior
and Aggregate Dynamics: Some General
Results,” Carlos Carvalho. Society for
Economic Dynamics annual meeting,
Cambridge, Massachusetts, July 12. With
Felipe Schwartzman. Also presented at the
Joint European Meeting of the European
Economic Association and the Econometric
Society, Milan, Italy, August 27.

“Current Account Dynamics and Monetary
Policy,” Andrea Ferrero. Joint European
Meeting of the European Economic
Association and the Econometric Society,
Milan, Italy, August 29. With Mark Gertler
and Lars E. O. Svensson.
“Revisiting Useful Approaches to Data-Rich
Macroeconomic Forecasting,” Jan Groen.
Joint European Meeting of the European
Economic Association and the Econometric
Society, Milan, Italy, August 31. With
George Kapetanios. Also presented at the
NBER–National Science Foundation Time
Series Conference, Aarhus, Denmark,
September 13.
“The Effect of Employee Stock Options on
Bank Investment Choice, Borrowing, and
Capital,” Hamid Mehran. Bank of Italy
seminar, Rome, Italy, July 14. With Joshua
Rosenberg. Also presented at the CESifo
Venice Summer Institute Workshop on
Executive Pay, Venice, Italy, July 16, and
the symposium “Financial Intermediaries
and Markets at the Cross-Roads: Economic
and Legal Perspectives on Financial Stability,
Liquidity, and Corporate Control,” cosponsored by the University of Amsterdam,
York University, the European Corporate

Research and Statistics Group

13

Research Update

■

Number 3, 2008

Governance Institute, and the Review
of Finance and held at the University of
Amsterdam, Amsterdam, the Netherlands,
September 26.
“What Do We Know about Executive
Compensation at Privately Held Firms?”
Hamid Mehran. CESifo Venice Summer
Institute Workshop on Executive Pay,
Venice, Italy, July 16. With Rebel Cole.

14

“Labor-Market Matching with Precautionary
Savings and Aggregate Fluctuations,”
Fourteenth International
Aysegül
Sahin.
,
,
Conference on Computing in Economics
and Finance, Paris, France, June 27. With
Per Krusell and Toshihiko Mukoyama.
“Labor Supply in a Frictional Labor
Market,” Aysegül
Ayşegül
Şahin.
University of
Sahin.
,
,
Southern California Marshall School of
Business seminar, Los Angeles, California,
September 26. With Per Krusell, Toshihiko
Mukoyama, and Richard Rogerson.
“Revisiting the Welfare Effects of Eliminating
Business Cycles: The Case of Short-Term
and Long-Term Unemployment,”
Ayşegül
Şahin.
Society for Economic
Aysegül
Sahin.
,
,
Dynamics annual meeting, Cambridge,
Massachusetts, July 12. With Per Krusell,
Toshihiko Mukoyama, and Anthony A.
Smith, Jr.

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

“Does Banks’ Corporate Control Benefit
Firms? Evidence from U.S. Banks’ Control
over Firms’ Voting Rights,” João Santos.
Financial Intermediation Research Society
Finance Conference, Anchorage, Alaska,
July 6. With Kristin Wilson.
“Financial Innovation and Corporate Default
Rates,” Asani Sarkar and Chenyang Wei.
Indian School of Business seminar,
Hyderabad, India, August 10. With Samuel
Maurer and Luu Nguyen. Also presented
at a Bank for International Settlements
seminar, Basel, Switzerland, August 27.
“Trend Inflation and Inflation Persistence
in the New Keynesian Phillips Curve,”
Argia Sbordone. Einaudi Institute for
Economics and Finance seminar, Rome,
Italy, June 25.
“Subprime Credit Securitization,”
Til Schuermann. RiskMetrics Group
conference, New York City,
September 11. ■

www.newyorkfed.org/research

Research and Statistics Group
Publications and Papers:
July-September 2008

Changes in the Timing Distribution
of Fedwire Funds Transfers
Olivier Armantier, Jeffrey Arnold,
and James McAndrews

Publications are available at
www.newyorkfed.org/research/
publication_annuals/index.html.

The Timing and Funding of CHAPS
Sterling Payments
Christopher Becher, Marco Galbiati,
and Merxe Tudela

ECONOMIC POLICY REVIEW,
VOL. 14

Understanding Risk Management
in Emerging Retail Payments
Michele Braun, James McAndrews,
William Roberds, and Richard Sullivan

No. 1, July 2008
Signal or Noise? Implications of the Term
Premium for Recession Forecasting
Joshua V. Rosenberg and Samuel Maurer

Poverty in New York City, 1969-99:
The Influence of Demographic Change,
Income Growth, and Income Inequality
Mark K. Levitan and Susan S. Wieler
Why the U.S. Treasury Began Auctioning
Treasury Bills in 1929
Kenneth D. Garbade
No. 2, September 2008
Special Issue: The Economics of Payments

Introduction
James McAndrews
Intraday Liquidity Management:
A Tale of Games Banks Play
Morten L. Bech
An Economic Analysis of LiquiditySaving Mechanisms
Antoine Martin and James McAndrews
Divorcing Money from Monetary Policy
Todd Keister, Antoine Martin,
and James McAndrews
Global Trends in Large-Value Payments
Morten L. Bech, Christine Preisig,
and Kimmo Soramäki

An Economic Perspective on the
Enforcement of Credit Arrangements:
The Case of Daylight Overdrafts
in Fedwire
Antoine Martin and David C. Mills

CURRENT ISSUES IN ECONOMICS
AND FINANCE, VOL. 14
No. 5, July 2008
The Federal Reserve’s Term Auction
Facility
Olivier Armantier, Sandra Krieger,
and James McAndrews
No. 6, August 2008
How Economic News Moves Markets
Leonardo Bartolini, Linda Goldberg,
and Adam Sacarny

STAFF REPORTS
No. 332, July 2008
Human Capital and Economic Activity
in Urban America
Jaison R. Abel and Todd M. Gabe
No. 333, July 2008
Banking Globalization, Monetary
Transmission, and the Lending Channel
Nicola Cetorelli and Linda S. Goldberg

Research and Statistics Group

15

Research Update

■

Number 3, 2008

No. 334, July 2008
Interpreting the Great Moderation:
Changes in the Volatility of Economic
Activity at the Macro and Micro Levels
Steven J. Davis and James A. Kahn
No. 335, July 2008
The Effect of the Term Auction Facility
on the London Inter-Bank Offered Rate
James McAndrews, Asani Sarkar,
and Zhenyu Wang
No. 336, July 2008
A Study of Competing Designs
for a Liquidity-Saving Mechanism
Antoine Martin and James McAndrews

16

No. 337, July 2008
Should There Be Intraday Money Markets?
Antoine Martin and James McAndrews
No. 338, July 2008
Financial Intermediary Leverage
and Value-at-Risk
Tobias Adrian and Hyun Song Shin
No. 339, July 2008
The Advantage of Flexible Targeting Rules
Andrea Ferrero
No. 340, August 2008
Pricing the Term Structure
with Linear Regressions
Tobias Adrian and Emanuel Moench
No. 341, August 2008
Juvenile Delinquent Mortgages:
Bad Credit or Bad Economy?
Andrew Haughwout, Richard Peach,
and Joseph Tracy

No. 342, September 2008
Central Bank Transparency and
Nonlinear Learning Dynamics
Stefano Eusepi
No. 343, September 2008
Stabilizing Expectations under Monetary
and Fiscal Policy Coordination
Stefano Eusepi and Bruce Preston
No. 344, September 2008
Have Amenities Become Relatively
More Important than Firm Productivity
Advantages in Metropolitan Areas?
Richard Deitz and Jaison R. Abel
No. 345, September 2008
What Drives Housing Prices?
James A. Kahn
No. 346, September 2008
Financial Intermediaries, Financial
Stability, and Monetary Policy
Tobias Adrian and Hyun Song Shin
No. 347, September 2008
ESOP Fables: The Impact of
Employee Stock Ownership Plans
on Labor Disputes
Peter Cramton, Hamid Mehran,
and Joseph Tracy
No. 348, September 2008
CoVaR
Tobias Adrian and Markus K. Brunnermeier

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.

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