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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 4

2007

ResearchUpdate
Research and Statistics Group

www.newyorkfed.org/research

Studies of Systemic Risk Draw Parallels between the Financial System
and Complex Systems in the Sciences and Engineering

T

he stability of the financial system
Understanding Systemic Risk.” The sesand the potential for systemic events
sions drew a broad group of scientists,
to alter its functioning have long
engineers, economists, and financial
been important issues for central bankers.
market practitioners to engage in a
While it is difficult to define systemic
cross-disciplinary examination of sysrisk, it is even harder to anticipate and
temic risk that could yield insights from
manage it with precision. In recent
the natural and physical sciences applidecades, financial innovation, rising insticable to economics and finance.
tutional consolidation, cross-border finanThe November 2007 issue of the
cial activity, and interconnectedness
Bank’s Economic Policy Review summaamong firms have materially changed the
rizes the key observations and findings
nature of systemic risk in the financial
of the conference. Presenters from the
system.
natural and mathematical sciences and
These developments suggest that older
the engineering disciplines describe the
models of systemic shocks in the financial
tools and techniques used to study syssystem may no longer fully capture the
temic collapse in interactive systems in
possible channels of propagation and
nature and engineering. Similarly,
feedback arising from major disturbances.
research economists offer studies of sysEven existing models may not account
temic risk in cross-border investments,
entirely for the increasing complexity of
the financial system.
To stimulate fresh think- A l s o i n t h i s i s s u e …
ing on the topic of systemic
risk, the New York Fed and New study identifies manufacturers’ repricing
costs as an important contributor to price rigidity. . . . . 3
the National Academy of
Staff Reports: New titles . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Sciences’ Board on
Mathematical Sciences and Other new publications. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Their Applications cospon- Papers presented at conferences . . . . . . . . . . . . . . . . . . . . 7
Papers recently published by Research Group economists . . 8
sored the conference
Publications and papers: October-December . . . . . . . . . 10
“New Directions for

RV oe ls ue ma rec h9 , U Np du amtbee r■ 4N, u 2m0b0e 6r 4 , 2 0 0 7

2

liquidity risk, and the payments system.
To provide a context for the discussions,
risk managers at large finance institutions
explain how systemic risk and shocks in
the financial system affect trading activities. A discussion of potential applications
to policy concludes the volume.
The conference identified certain
concepts that were key for both economists and scientists in studying systemic
risk, including nonlinearity, synchrony
and coordinated behavior, path dependence, hysteresis, and multiple equilibria.
However, differences were also found. For
example, expectations and anticipatory

behavior play a role in economics that is
absent in analysis of ecosystems or the
electrical grid in the natural sciences and
engineering; conversely, researchers in
the physical sciences and engineering use
computational models that are on a much
larger scale than those customarily used
by economists.
The volume, observe the report editors,
“was prepared to share some of the
insight and excitement generated by the
conference and to encourage further
cross-disciplinary conversations.” It is
available at www.newyorkfed.org/
research/epr/2007n1.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.

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 Study Identifies Manufacturers’ Repricing Costs
as an Important Contributor to Price Rigidity

O

ne of the more puzzling phenomena
in economics is price rigidity, or the
tendency of prices to remain constant despite changes in supply and
demand. In “Sticky Prices: Why Firms
Hesitate to Adjust the Price of Their
Goods” (Current Issues in Economics
and Finance, vol. 13, no. 10), authors
Pinelopi Goldberg and Rebecca
Hellerstein argue that price rigidity
derives in significant measure from
repricing costs at the wholesale
level.
Repricing costs, the authors explain,
include the managerial time to determine
a new optimal price and the costs of
implementing and advertising the new
price, as well as the risk of losing longterm customers if the price rises. While
some earlier studies have suggested a
link between repricing costs and price
stickiness, no consensus on the size and
importance of these costs has been
reached.
Taking the imported beer market as
their subject, Goldberg and Hellerstein
estimate the costs of repricing to be
0.4 percent of firm revenue for manufacturers and 0.1 percent of firm revenue
for retailers. While not large in absolute
terms, these costs are of sufficient magnitude to discourage firms—especially manufacturers—from adjusting their prices.

Goldberg and Hellerstein also compare
repricing costs with two other sources of
price rigidity for imported goods: markup
adjustment, or the tendency of firms to
moderate any increase in their prices in
order to preserve market share, and the
existence of a “local” component in the
price of imported goods that does not
fluctuate with changes in the exchange
rate. All three factors create price stickiness, the authors note, by limiting the
responsiveness of prices to exchange
rates or, “in the language of economists,
by rendering the ‘pass-through’ of
exchange rate changes to prices ‘incomplete.’” The authors’ calculations suggest
that while markup adjustment and local
costs account for the largest share of the
incomplete pass-through observed in the
data on beer prices, repricing costs are a
“substantial contributor” to the low passthrough rates.
According to Goldberg and Hellerstein,
the approach used in their study to analyze price rigidity is not specific to the
beer market: “The methodology we propose . . . can be more generally applied
to any market for which data are recorded
at frequent enough intervals to identify
the points of price adjustment.”
The article is available at
www.newyorkfed.org/research/
current_issues/ci13-10.html.

Research and Statistics Group

3

Research Update

■

Number 4, 2007

New Titles in the Staff
Reports Series

T

he following new staff reports are
available at www.newyorkfed.org/
research/staff_reports.

MACROECONOMICS
AND GROWTH
No. 310, December 2007
Is There Still an Added-Worker Effect?
Chinhui Juhn and Simon Potter

4

Using matched March Current Population
Surveys, Juhn and Potter examine labor
market transitions of husbands and wives.
They find that the “added-worker effect”—
the greater propensity of nonparticipating
wives to enter the labor force when their
husbands exit employment—is still important among a subset of couples, but that the
overall value of marriage as a risk-sharing

arrangement has diminished because of the
greater positive co-movement of employment within couples. While positive assortative matching on education did increase
over time, this shift in the composition of
couple types alone cannot account for the
increased positive correlation.

MICROECONOMICS
No. 306, October 2007
Vouchers, Public School Response,
and the Role of Incentives: Evidence
from Florida
Rajashri Chakrabarti
Chakrabarti analyzes the behavior of public
schools facing vouchers. The literature on
the effects of voucher programs on public
schools typically focuses on student and
mean school scores. This paper attempts to
go inside the black box to investigate some
of the ways in which schools facing the
threat of vouchers in Florida behaved.

Other New Publications
■

■

Upstate New York Regional Review: In “Aging in Place in Upstate New York”
(Volume 2, Number 4), Jane Humphreys argues that senior homeowners may find
it hard to remain in their homes as they grow older because of a growing disparity
between the features of the houses they own and the housing they need. The
resulting change in demand for housing products and services is especially significant upstate, where most seniors are homeowners and the housing stock is dominated by older, single-family homes.
www.newyorkfed.org/research/regional_economy/upstate/upstatenews2-2.html
Upstate New York At-a-Glance: Jason Bram, James Orr, and Rae Rosen observe
that the upstate economy has continued to undergo significant restructuring, with
job gains in services sectors such as health care, education, business services, and
leisure and hospitality offsetting losses in manufacturing (“Upstate New York
Employment Trends,” Number 3, December 2007). According to the authors, a
modest upward trend should continue in 2007, with the creation of 20,000 net
new jobs—but results will be mixed across upstate metro areas.
www.newyorkfed.org/research/regional_economy/glance/upstate_glance2_07.html

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

Using highly disaggregated school-level
data, a difference-in-differences estimation
strategy, and a regression discontinuity
analysis, she finds that the threatened
schools tended to focus more on students
below the minimum criteria cutoffs rather
than equally on all; interestingly, however,
this improvement did not come at the
expense of higher performing students.
Second, consistent with incentives, the
schools focused on writing rather than
reading and math.
No. 311, December 2007
Firms and Flexibility
Bart Hobijn and Ay egül ahin
Hobijn and ahin study the effects of labor
market rigidities and frictions on firm-size
distributions and dynamics. They introduce
a model of endogenous entrepreneurship,
labor market frictions, and firm-size
dynamics with many types of rigidities,
such as hiring and firing costs, search frictions with vacancy costs, unemployment
benefits, firm entry costs, and a tax wedge
between wages and labor costs. The
authors use the model to analyze how each
rigidity explains firm-size differentials
between the United States and France.
They find that when all rigidities and frictions except hiring costs and search frictions are included, the model accounts for
much of the firm-size differentials between
the United States and France. The addition
of search frictions with vacancy costs generates implausibly large differentials in
firm-size distributions.

BANKING AND FINANCE
No. 304, October 2007
Buybacks in Treasury Cash and
Debt Management
Kenneth D. Garbade and Matthew Rutherford
This paper examines the use of buybacks
in Treasury cash and debt management.
Garbade and Rutherford review the
mechanics and results of the buyback
operations conducted in 2000-01, during a
time of budget surpluses, and assess the
prospective use of buybacks in the absence
of a surplus. Possible future applications
include 1) managing the liquidity of the
new-issue markets when deficits are
declining; 2) actively promoting the liquidity of the new-issue markets; 3) limiting
the accumulation of large Treasury cash
balances; and 4) smoothing week-to-week
fluctuations in Treasury bill offerings.
No. 305, October 2007
The Effect of Employee Stock Options
on Bank Investment Choice, Borrowing,
and Capital
Hamid Mehran and Joshua Rosenberg
The authors test the hypothesis that granting
employee stock options motivates CEOs of
banking firms to undertake riskier projects.
They also investigate whether granting
employee stock options reduces the bank’s
incentive to borrow while inducing a buildup
of regulatory capital. Using a sample of 549
bank-years for publicly traded banks from
1992 to 2002, they find some evidence
that the bank’s equity volatility (total as
well as residual) and asset volatility
increase as CEO stock option holdings
increase. In addition, it appears that granting
employee stock options motivates banks to
reduce their borrowing, as evidenced by
lower levels of interest expense and federal
funds borrowing. Furthermore, the authors
show that banking firms that grant more
options to their employees build up more
capital in future years.

Research and Statistics Group

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Research Update

■

Number 4, 2007

No. 307, November 2007
Macro News, Risk-Free Rates, and
the Intermediary: Customer Orders
for Thirty-Year Treasury Futures
Albert J. Menkveld, Asani Sarkar,
and Michel van der Wel

6

Customer order flow correlates with permanent price changes in equity and non-equity
markets. Menkveld, Sarkar, and van der Wel
examine macro news events in the thirtyyear Treasury futures market to identify
causality from customer flow to risk-free
rates. They remove the positive feedback
trading effect and establish that, in the fifteen minutes subsequent to the news,
intermediaries rely on customer orders to
determine a substantial part of the
announcement’s effect on risk-free rates—
about one-third relative to the instantaneous
effect. Intermediaries appear to benefit from
privately observing informed customers,
since their own-account trade profitability
correlates with access to customer flow,
controlling for volatility, competition, and
the macro “surprise.”
No. 308, November 2007
Regulation, Subordinated Debt, and
Incentive Features of CEO Compensation
in the Banking Industry
Kose John, Hamid Mehran, and Yiming Qian
The authors study CEO compensation in
the banking industry by considering banks’
unique claim structure in the presence of
two types of agency problems: the standard
managerial agency problem and the riskshifting problem between shareholders and
debtholders. They empirically test two

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

hypotheses derived from this framework:
that the pay-for-performance sensitivity of
bank CEO compensation 1) decreases with
the total leverage ratio and 2) increases
with the intensity of monitoring provided
by regulators and nondepository (subordinated) debtholders. They construct an
index of the intensity of outsider monitoring based on four variables: the subordinated debt ratio, subordinated debt rating,
nonperforming loan ratio, and BOPEC rating. John, Mehran, and Qian find supporting evidence for both hypotheses.
No. 309, November 2007
Payday Holiday: How Households Fare
after Payday Credit Bans
Donald P. Morgan and Michael R. Strain
Payday loans are widely condemned as a
“predatory debt trap.” Morgan and Strain
test that claim by researching how households in Georgia and North Carolina have
fared since those states banned payday
loans in May 2004 and December 2005.
Compared with households in all other
states, households in Georgia have
bounced more checks, complained more to
the Federal Trade Commission about
lenders and debt collectors, and filed for
Chapter 7 bankruptcy protection at a higher
rate. North Carolina households have fared
about the same. This negative correlation—
reduced payday credit supply, increased
credit problems—contradicts the debt-trap
critique of payday lending, but is consistent
with the hypothesis that payday credit is
preferable to substitutes such as the
bounced-check “protection” sold by credit
unions and banks or loans from pawnshops. ■

www.newyorkfed.org/research

Papers Presented by Economists in the Research and Statistics Group
“Extracting Inflation Expectations from
the Real and Nominal Term Structures,”
Tobias Adrian. European Central Bank
workshop, Frankfurt, Germany, December 19.
With Hao Wu.
“Liquidity and Leverage,” Tobias Adrian.
Bank of England seminar, London,
England, November 8. With Hyun Song
Shin. Also presented at a Duke University
conference, Durham, North Carolina,
November 16, and a European Central
Bank conference, Frankfurt, Germany,
November 28.
“The Federal Home Loan Bank System:
The Lender of Next to Last Resort?”
Morten Bech. University of Copenhagen seminar, Copenhagen, Denmark, December 19.
“Single European Payments Area: A U.S.
Perspective,” Morten Bech. Télécom Paris
conference “The Economics of Payment
Systems: From Theoretical to Empirical
Issues,” Paris, France, October 26.
“Are Charter Schools Perceived to Be
Better than Regular Public Schools?
Evidence from a New Approach Using
Private School Enrollment Patterns,”
Rajashri Chakrabarti. Twenty-ninth Annual
Association for Public Policy Analysis and
Management Research Conference,
Washington, D.C., November 10. With
Joydeep Roy. Also presented at the Southern
Economic Association annual conference,
New Orleans, Louisiana, November 21.
“The Intended and Unintended
Consequences of No Child Left Behind:
Evidence from Wisconsin,” Rajashri
Chakrabarti. Twenty-ninth Annual
Association for Public Policy Analysis and
Management Research Conference,
Washington, D.C., November 9. Also presented at the Southern Economic
Association annual conference,
New Orleans, Louisiana, November 20.

“Vouchers, Public School Response,
and the Role of Incentives,” Rajashri
Chakrabarti. University of Arkansas seminar, Fayetteville, Arkansas, November 30.
“How Do Treasury Dealers Manage Their
Positions?” Michael Fleming and Joshua
Rosenberg. 2007 Financial Management
Association Annual Meeting, Orlando,
Florida, October 19.
“The Lending Channel in Emerging
Markets: Are Foreign Banks Different?”
Linda Goldberg. European Central Bank
conference, Frankfurt, Germany,
November 28.
“Macroeconomic Interdependence and the
International Role of the Dollar,” Linda
Goldberg. International Monetary Fund
conference, Washington, D.C., November 15.
“Credit Derivatives and Bank Credit
Supply,” Beverly Hirtle. European Central
Bank conference, Frankfurt, Germany,
November 30.
“Varieties and the Transfer Problem:
The Extensive Margin of Current Account
Adjustment,” Paolo Pesenti. Columbia
University Department of Economics seminar, New York City, October 31. With
Giancarlo Corsetti and Philippe Martin.
“Market Sidedness: Insights into Motives
for Trade Initiation,” Asani Sarkar. Cornell
University seminar, Ithaca, New York,
November 16. With Robert Schwartz.
“Firm Heterogeneity and Credit Risk
Diversification,” Til Schuermann. Standard
& Poor’s, New York City, November 2. With
Samuel Hanson and M. Hashem Pesaran. ■

Research and Statistics Group

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Research Update

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Number 4, 2007

Recently Published
Mary Amiti. 2007. “China’s Export Boom,”
with Caroline Freund. IMF Finance and
Development 44, no. 3 (September): 38-41.
Mary Amiti. 2007. “Trade Liberalization,
Intermediate Inputs, and Productivity:
Evidence from Indonesia,” with Jozef
Konings. American Economic Review 97,
no. 5 (December): 1611-38.

8

Mary Amiti. 2007. “Will the Doha Round
Lead to Preference Erosion?” with John
Romalis. IMF Staff Papers 54, no. 2
(September): 338-84.
Morten Bech. 2007. “Central Banks’
Interest Calculating Conventions: Deviating
from the Intraday/Overnight Status Quo,”
with George Speight, Matthew Willison,
and Jing Yang. In Stephen Millard, Andrew
Haldane, and Victoria Saporta, eds.,
The Future of Payment Systems, 160-74.
London: Routledge.
Morten Bech. 2007. “Congestion and
Cascades in Payment Systems,” with Walter
E. Beyeler, Robert J. Glass, and Kimmo
Soramäki. Physica A: Statistical Mechanics
and Its Applications 384, no. 2 (October
15): 693-718.
Morten Bech. 2007. “The Diffusion of
Real-Time Gross Settlement.” In Stephen
Millard, Andrew Haldane, and Victoria
Saporta, eds., The Future of Payment
Systems, 189-205. London: Routledge.
Morton Bech. 2007. “Interbank Payment
System and Wide-Scale Disruptions.” In
Philipp Hartmann, ed., Risk Measurement
and Systemic Risk. Proceedings of the 4th
Joint Central Bank Research Conference
on Risk Measurement and Systemic Risk.
Frankfurt, Germany: European Central Bank.

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

Morten Bech. 2007. “New Approaches for
Payment System Simulation Research,”
with Kimmo Soramäki, Walter E. Beyeler,
and Robert J. Glass. In Harry Leinonen, ed.,
Simulation Studies of Liquidity Needs,
Risks, and Efficiency in Payment Networks.
Proceedings of the Bank of Finland Payment
and Settlement System Seminars, 2005-06.
Morten Bech. 2007. “The Topology of
Interbank Payment Flows,” with Kimmo
Soramäki, Jeffrey Arnold, Robert J. Glass,
and Walter E. Beyeler. Physica A:
Statistical Mechanics and Its Applications 379,
no. 1 (June 1): 317-33.
Linda Goldberg. 2007. “Trade Invoicing in
the Accession Countries: Are They Suited
to the Euro?” In Jeffrey A. Frankel and
Christopher A. Pissarides, eds., NBER
International Seminar on Macroeconomics
2005, 357-93. Cambridge, Mass.: MIT Press.
Beverly Hirtle. 2007. “The Impact
of Network Size on Bank Branch
Performance.” Journal of Banking and
Finance 31, no. 12 (December): 3782-805.
Antoine Martin. 2007. “Barriers to
Network-Specific Innovation,” with
Michael Orlando. Review of Economic
Dynamics 10, no. 4 (October): 705-28.
Antoine Martin. 2007. “Optimality of
the Friedman Rule in an Overlapping
Generations Model with Spatial
Separation,” with Joseph H. Haslag.
Journal of Money, Credit, and Banking 39,
no. 7 (October): 1741-58.

www.newyorkfed.org/research

Jonathan McCarthy. 2007. “Pass-Through
of Exchange Rates and Import Prices to
Domestic Inflation in Some Industrialized
Economies.” Eastern Economic Journal 33,
no. 4 (fall): 511-37.
Hamid Mehran. 2007. “The Economics
of Conflicts of Interest in Financial
Institutions,” with René M. Stulz. Journal
of Financial Economics 85, no. 2 (August):
267-96.

Simon Potter. 2007. “Estimating and
Forecasting in Models with Multiple
Breaks,” with Gary Koop. Review of
Economic Studies 74, no. 3 (July): 763-89.

Kevin Stiroh. 2007. “Explaining a
Productive Decade,” with Stephen D.
Oliner and Daniel E. Sichel. Brookings
Papers on Economic Activity, no. 1: 81-137.
Andrea Tambalotti. 2007. “An Investigation of the Gains from Commitment in
Monetary Policy,” with Ernst Schaumburg.
Journal of Monetary Economics 54, no. 2
(March): 302-24.
Chenyang Wei. 2007. “Governance
Mechanisms and Bond Prices,” with K. J.
Martijn Cremers and Vinay B. Nair.
Review of Financial Studies 20, no. 5
(September): 1359-88. ■

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Research and Statistics Group

9

Research Update

■

Number 4, 2007

Research and Statistics Group
Publications and Papers:
October-December 2007
Publications are available at
www.newyorkfed.org/research/
publication_annuals/index.html.

ECONOMIC POLICY REVIEW,
VOL. 13

10

No. 2, November 2007
New Directions for Understanding
Systemic Risk
A Report on a Conference Cosponsored
by the Federal Reserve Bank of New York
and the National Academy of Sciences,
May 18-19, 2006
No. 3, December 2007
Hedge Funds, Financial
Intermediation, and Systemic Risk
John Kambhu, Til Schuermann,
and Kevin J. Stiroh

A Comparison of Measures
of Core Inflation
Robert Rich and Charles Steindel
The Role of Retail Banking in the U.S.
Banking Industry: Risk, Return, and
Industry Structure
Timothy Clark, Astrid Dick, Beverly Hirtle,
Kevin J. Stiroh, and Robard Williams

FORTHCOMING
Signal or Noise? Implications of the
Term Premium for Recession
Forecasting
Samuel Maurer and Joshua V. Rosenberg
Understanding Risk Management in
Emerging Retail Payments
Michele Braun, James McAndrews,
William Roberds, and Richard Sullivan

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

CURRENT ISSUES IN
ECONOMICS AND FINANCE,
VOL. 13
No. 9, October 2007
The Foreign-Born Population in
Upstate New York
James Orr, Susan Wieler,
and Joseph Pereira
Second District Highlights
No. 10, November 2007
Sticky Prices: Why Firms Hesitate
to Adjust the Price of Their Goods
Pinelopi Goldberg and Rebecca Hellerstein
No. 11, December 2007
Financial Globalization and the U.S.
Current Account Deficit
Matthew Higgins and Thomas Klitgaard

STAFF REPORTS
No. 304, October 2007
Buybacks in Treasury Cash and Debt
Management
Kenneth D. Garbade and Matthew Rutherford
No. 305, October 2007
The Effect of Employee Stock Options
on Bank Investment Choice,
Borrowing, and Capital
Hamid Mehran and Joshua Rosenberg
No. 306, October 2007
Vouchers, Public School Response,
and the Role of Incentives: Evidence
from Florida
Rajashri Chakrabarti
No. 307, November 2007
Macro News, Risk-Free Rates, and
the Intermediary: Customer Orders
for Thirty-Year Treasury Futures
Albert J. Menkveld, Asani Sarkar,
and Michel van der Wel

www.newyorkfed.org/research

No. 308, November 2007
Regulation, Subordinated Debt,
and Incentive Features of CEO
Compensation in the Banking Industry
Kose John, Hamid Mehran, and Yiming Qian
No. 309, November 2007
Payday Holiday: How Households Fare
after Payday Credit Bans
Donald P. Morgan and Michael R. Strain

No. 310, December 2007
Is There Still an Added-Worker Effect?
Chinhui Juhn and Simon Potter
No. 311, December 2007
Firms and Flexibility
Bart Hobijn and Ay egül ahin

11

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