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federal reserve bank of new york ■■ Number 4,
3, 2010
Research and Statistics Group

Study Attributes Low Market Share of ARMs
to Shifts in Term Structure of Interest Rates,
Decline of Jumbo Mortgage Market


n the past several years, U.S. homebuyers have

ARMs and the “payment shock” triggered by ­interest

increasingly opted for fixed-rate mortgages over

rate resets on ARMs drove down demand for the

adjustable-rate mortgages (ARMs). The ARM

adjustable-rate mortgages. A third view attributes the

share—which comprised 60 to 70 percent of all

decline to changes in the term structure of interest

mortgage originations at one point in the mid-1990s—

rates and their effects on the pricing of mortgages.

is now close to historic lows, with less than 10 percent

To test these competing theories, Moench,

of all new mortgages carrying an adjustable interest rate.
In a recent study in Current Issues in Economics

­Vickery, and Aragon conduct a statistical analysis
using loan-level mortgage data from Lender Process-

and Finance (vol. 16, no. 8, “Why Is the Market Share

ing Services and from the Federal Housing Finance

of Adjustable-Rate Mortgages So Low?”), authors

Agency’s Monthly Interest Rate Survey. They con-

Emanuel Moench, James Vickery, and Diego Aragon

struct a model that contains a variety of variables that

explore the reasons for this trend. They conclude that

might help explain mortgage choice, including the

the fall in the ARM share predominantly reflects the

term premium on Treasury yields, the spread between

same long-run factors that drove mortgage choice in

interest rates on fixed- and adjustable-rate mortgages,

earlier periods—namely, the term structure of interest

and variables that capture changes in lending stan-

rates and its effects on the pricing of different kinds

dards and household liquidity constraints.
The model performs well in explaining the
­decline in the market share of adjustable-rate mortgages in recent years. A “rule-of-thumb” variable
that measures the difference between the current

of mortgages. Supply-side factors, in particular the
contraction of the “jumbo” mortgage market, also
play a role.
The authors begin their analysis by reviewing
the competing explanations for the decline in the
ARM share. One view holds that this decline is closely
related to the financial crisis, and particularly to
such developments as the collapse of the securitized
nonprime mortgage market, where ARMs predominated. A second and related view holds that the heavy
publicity surrounding high default rates on subprime

Also in this issue…
New in the Economic Policy Review����������������������������� 3
Staff Reports: New titles������������������������������������������������� 4
Most downloaded publications������������������������������������ 6
Papers presented at conferences����������������������������������� 6
Papers recently published by Research Group
­economists����������������������������������������������������������������� 8
Publications and papers: October-December������������� 9

Research UPDATE n Number 4, 2010
interest rate on fixed-rate mortgages and the ­average
adjustable rate over the past three years proves to
be the most important determinant of the ARM
share historically, and also accounts for most of the
recent decline in the popularity of adjustable-rate
mortgages. Significantly, this finding suggests that
households base their choice of a fixed- or adjustablerate ­mortgage in part on past interest rates, not just
current ones.
In addition, the authors conclude that a drop
in the fraction of jumbo mortgage loans (loans that

do not conform to the limits established for mortgages purchased by the housing GSEs Fannie Mae
and ­Freddie Mac) may also have contributed to the
reduced ARM share. For a variety of institutional
­reasons, the share of ARMs is significantly higher in
the jumbo market than in the “conforming” ­market.
As the jumbo market has contracted—owing to
falling home prices and rising limits on the size of
conforming loans, factors that are both related to the
financial crisis—the prevalence of adjustable-rate
mortgages has decreased as well. n

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
■■ Second

Issues in Economics and Finance—concise studies of topical economic and financial issues.

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.

federal reserve bank of new york

New in the Economic Policy Review
Volume 16, Number 2

specification shares with more elaborate versions.
The authors then apply the estimated model to study
the sources of the sudden increase in inflation that
­occurred in the first half of 2004. One important lesson
derived from this exercise is that the management of
expectations can be a more effective tool for stabilizing inflation than actual movements in the policy rate.
This result is consistent with the increasing focus on
the pronouncements of central bankers regarding their
future actions.

Program Design, Incentives, and Response:
Evidence from Educational Interventions
Rajashri Chakrabarti
In an effort to reform K-12 education, policymakers
have introduced school vouchers—scholarships that
make students eligible to transfer from public to private
schools—in some U.S. school districts. Chakrabarti
­analyzes two such educational interventions in the
United States: the Milwaukee and Florida voucher
programs. Under the Milwaukee program, vouchers
were imposed from the outset, so that all low-income
public school students became eligible for vouchers to
transfer to private schools. In contrast, schools in the
Florida program were only threatened with vouchers,
with students of a particular school becoming e­ ligible
for vouchers only if the school received two “F” grades
in a period of four years. Unlike the Milwaukee schools,
Florida schools therefore had an incentive to avoid
vouchers. Using school-level data from Florida and
Wisconsin, the author shows that the performance
­effects of the threatened public schools under the
Florida program have exceeded those of corresponding
schools in Milwaukee. The lessons of her study are
broadly applicable to New York City’s educational
reform efforts.

The Introduction of the TMPG Fails Charge for
U.S. Treasury Securities
Kenneth D. Garbade, Frank M. Keane, Lorie Logan,
Amanda Stokes, and Jennifer Wolgemuth
The TMPG fails charge for U.S. Treasury securities
provides that a buyer of Treasury securities can claim
monetary compensation from the seller if the seller fails
to deliver the securities on a timely basis. The charge
was introduced in May 2009 and replaced an existing
market convention of simply postponing—without any
explicit penalty and at an unchanged invoice price—a
seller’s obligation to deliver Treasury securities if the
seller fails to deliver the securities on a scheduled
settlement date. This study explains how a proliferation
of settlement fails following the insolvency of L
­ ehman
Brothers Holdings Inc. in September 2008 led the
Treasury Market Practices Group (TMPG)—a group
of market professionals committed to supporting the
integrity and efficiency of the U.S. Treasury market—to
promote a change in the existing market convention.
The change—the introduction of the fails charge—was
significant because it mitigated an important dysfunctionality in the secondary market for U.S. Treasury
­securities and because it stands as an example of the
value of cooperation between the public and private
sectors in responding to altered market conditions in a
flexible, timely, and innovative fashion.

Policy Analysis Using DSGE Models: An Introduction
Argia M. Sbordone, Andrea Tambalotti, Krishna Rao,
and Kieran Walsh
Many central banks have come to rely on dynamic
stochastic general equilibrium, or DSGE, models to
inform their economic outlook and to help formulate
their policy strategies. But while their use is familiar to
policymakers and academics, these models are t­ ypically
not well known outside these circles. Sbordone et al.
introduce the basic structure, logic, and application of
the DSGE framework to a broader public by ­providing
an example of its use in monetary policy analysis. They
present and estimate a simple New Keynesian DSGE
model, highlighting the core features that this basic

Articles are available at­


Research UPDATE n Number 4, 2010

New Titles in the Staff Reports Series
The following staff reports are available at

finds that g­ aining parental approval and enjoying a
field of study both academically and professionally
are outcomes that students feel are important for both
majors. However, the author does find that students
act strategically in choosing their majors, selecting
two that differ in their chances of completion and
­difficulty and in finding a job upon graduation.

Macroeconomics and Growth
No. 476, November 2010
Fitting Observed Inflation Expectations
Marco Del Negro and Stefano Eusepi
This paper provides evidence on the extent to which
inflation expectations generated by a standard
­Christiano et al. (2005)/Smets and Wouters (2003)–
type DSGE model are in line with what is observed in
the data. Del Negro and Eusepi consider three variants of this model that differ in terms of the behavior
of, and the public’s information on, the central banks’
inflation target, allegedly a key determinant of inflation expectations. They find that: 1) time-variation in
the inflation target is needed to capture the evolution
of expectations during the post-Volcker period; 2) the
variant in which agents have imperfect information is
strongly rejected by the data; 3) inflation expectations
appear to contain information that is not present in
the other series used in estimation; and 4) none of the
models fully captures the dynamics of this variable.

No. 479, November 2010
An Introduction to the FRBNY Consumer
Credit Panel
Donghoon Lee and Wilbert van der Klaauw
In this paper, the authors introduce the FRBNY
­Consumer Credit Panel, a new longitudinal database
with detailed information on consumer debt and
credit. The panel uses a unique sample design and
information derived from consumer credit reports
to track individuals’ and households’ access to and
use of credit at a quarterly frequency. In any given
quarter ranging from the first quarter of 1999 to the
present, the panel can be used to compute nationally
representative estimates of the levels and changes in
various aspects of individual and household liabilities.
In addition to describing the sample design, the use
of sample weights, and the credit report information
included in the database, the authors provide some
comparisons of population statistics and consumer
debt estimates derived from the panel with those
based on data from the American Community Survey
and the Flow of Funds Accounts of the United States.

No. 478, November 2010
Double Majors: One for Me, One for the Parents?
Basit Zafar
This paper investigates how students decide on the
composition of their paired majors, that is, whether
the majors are substitutes or complements. Zafar
collects innovative data on subjective expectations
from a sample of Northwestern University sophomores and incorporates it in a choice model of double
majors that also captures the notion of specialization. He finds that enjoying the coursework and
gaining the approval of one’s parents are the most
important determinants in the choice of majors. The
model estimates reject the hypothesis that students
major in one field to pursue their own interests and
in another for their parents’ approval. Instead, Zafar

No. 480, December 2010
The Financial Crisis at the Kitchen Table: Trends in
Household Debt and Credit
Meta Brown, Andrew Haughwout, Donghoon Lee, and
Wilbert van der Klaauw
The FRBNY Consumer Credit Panel, created from a
sample of U.S. consumer credit reports, is an ongoing
panel of quarterly data on individual and household
debt. The panel shows a substantial run-up in total
consumer indebtedness between the first quarter
of 1999 and the peak in the third quarter of 2008,
­followed by a steady decline through the third quarter

federal reserve bank of new york
of 2010. During the same period, delinquencies rose
sharply: Delinquent balances peaked at the close of
2009 and then began to decline again. This paper
documents these trends and discusses their sources.
The authors focus particularly on the decline in debt
outstanding since mid-2008, which has been the subject of considerable policy and media interest. While
the magnitudes of balance declines and borrower
defaults, represented as “charge-offs” on consumers’
credit reports, have been similar, the authors find that
debt pay-down has been more pronounced than this
simple comparison might indicate.

Brothers, for which the authors provide some
evidence. This suggests that runs in the tri-party repo
market may occur precipitously—as traditional bank
runs do—rather than manifest themselves as large
increases in margins.

Quantitative Methods
No. 475, October 2010
Equity Premium Predictions with Adaptive
Macro Indexes
Jennie Bai
Fundamental economic conditions are crucial determinants of equity premia. However, commonly used
predictors do not adequately capture the changing
nature of economic conditions and hence have limited
power in forecasting equity returns. To address the
inadequacy, this paper constructs macro indexes from
large data sets and adaptively chooses optimal indexes
to predict stock returns. Bai finds that adaptive macro
indexes explain a substantial fraction of the shortterm variation in future stock returns and have more
forecasting power than both the historical average
of stock returns and commonly used predictors. The
forecasting power exhibits a strong cyclical ­pattern,
implying the ability of adaptive macro indexes to
capture time-varying economic conditions. This
finding highlights the importance of using dynamically measured economic conditions to investigate
empirical linkages between the equity premium and
macroeconomic fundamentals. n

Banking and Finance
No. 477, November 2010
The Tri-Party Repo Market before
the 2010 Reforms
Adam Copeland, Antoine Martin, and Michael Walker
This paper provides a descriptive and quantitative
­account of the tri-party repo market before the
­reforms proposed in 2010 by the Task Force on
Tri-Party Repo Infrastructure. Copeland, Martin, and
Walker provide an extensive description of the
mechanics of this market. They also use data from
July 2008 to early 2010 to document quantitative
features of the market. The authors find that both the
level of haircuts and the amount of funding were
surprisingly stable. The stability of the margins is in
contrast to evidence from other repo markets.
Perhaps surprisingly, the data reveal relatively few
signs of market stress for dealers other than Lehman


Research UPDATE n Number 4, 2010

Most Downloaded Publications


SSRN website, fourth-quarter 2010:

isted below are the most sought-after
Research Group articles and papers from
the New York Fed’s website and from the
Bank’s page on the Social Science Research
Network site (

■■ “Understanding

the Securitization of Subprime
Mortgage Credit,” by Adam B. Ashcraft and
Til Schuermann (Staff Reports, no. 318,
March 2008) – 446 downloads

New York Fed website, fourth-quarter 2010:

■■ “ The

Corporate Governance of Banks,” by
Jonathan R. Macey and Maureen O’Hara
(Economic Policy Review, vol. 9, no. 1,
April 2003) – 199 downloads

■■ “Shadow Banking,” by Zoltan Pozsar, Tobias Adrian,

Adam Ashcraft, and Hayley Boesky (Staff Reports,
no. 458, July 2010) – 2,674 downloads

■■ “Determinants

and Impact of Sovereign Credit
Ratings,” by Richard Cantor and Frank Packer
(Economic Policy Review, vol. 2, no. 2,
­October 1996) – 175 downloads

■■ “Understanding

the Securitization of Subprime
Mortgage Credit,” by Adam B. Ashcraft and
Til Schuermann (Staff Reports, no. 318,
March 2008) – 1,217 downloads

For lists of the top-ten downloads, visit

■■ “Why Are Banks Holding So Many Excess Reserves?”

by Todd Keister and James McAndrews (Staff
Reports, no. 380, July 2009) – 959 downloads

Papers Presented
“Funding Liquidity Risk and the Cross-Section of
Stock Returns,” Tobias Adrian. European Central
Bank Conference, “The Role of Financial Market
Liquidity in Periods of Turbulence: Theory, ­
Empirical Evidence, and Implications for Policy,”
Frankfurt, Germany, October 14. With Erkko Etula
and Tyler Muir.

Policy, Queen’s University, Kingston, Ontario,
Canada, October 21. With John Karl Scholz and
Ananth Seshadri.
“Sectoral Price Facts in a Sticky-Price Model,”
Carlos Carvalho. Bank of Spain seminar, Madrid,
Spain, October 8. With Jae Won Lee. Also presented at a seminar cosponsored by the Center for
Financial Studies, the Deutsche Bundesbank, and
the European Central Bank, held at the European
Central Bank, Frankfurt, Germany, October 6, and
a University of Maryland Economics Department
seminar, College Park, Maryland, November 10.

“Measuring Systemic Risk,” Tobias Adrian, NBER
seminar, Cambridge, Massachusetts, October 27.
With Viral V. Acharya, Lasse H. Pedersen, Thomas
Philippon, and Matthew Richardson.
“Shadow Banking,” Tobias Adrian. Centre for
Economic Policy Research Conference, “The Future
of Regulatory Reform,” London, England, October 4.
With Zoltan Pozsar, Adam Ashcraft, and Hayley Boesky.

“Credit Market Competition and the Nature of
Firms,” Nicola Cetorelli. New York University
Economics Department seminar, New York City,
October 7.

“A New Test of Borrowing Constraints for Education,”
Meta Brown. Canadian Research Data Centre
Network Conference, “Economic Relations
between Children and Parents,” held at the John
Deutsch Institute for the Study of Economic

“Intended and Unintended Consequences of Merit
Aid,” Rajashri Chakrabarti. Association for Public
Policy Analysis and Management conference, Boston,
Massachusetts, November 5. With Joydeep Roy.

federal reserve bank of new york
“The Impact of Competition on Technology
Adoption: An Apples-to-PCs Analysis,” Adam
Copeland. University of North Carolina Economics
Department seminar, Chapel Hill, North Carolina,
November 3. With Adam Shapiro. Also presented
at a University of Toronto Economics Department
seminar, Toronto, Ontario, Canada, November 8;
a University of Minnesota Economics Department
seminar, Minneapolis, Minnesota, November 10; and
the Southern Economic Association annual meeting,
Atlanta, Georgia, November 22.

“Bailouts and Financial Fragility,” Todd Keister.
City University of New York Graduate Center
seminar, New York City, October 26. Also presented
at a ­Wharton School Finance Department Micro
seminar, University of Pennsylvania, Philadelphia,
Pennsylvania, November 4, and the London School
of Economics and Political Science Financial Markets
Group–AXA Research Fund Conference on ­Financial
Intermediation, Banking and Macro-Stability,
­London, England, December 2.
“Labor-Dependent Capital Income Taxation that
Encourages Work and Saving,” Sagiri Kitao. Queen’s
University Economics Department seminar, Kingston,
Ontario, Canada, October 7. Also presented at a State
University of New York at Albany Economics Department seminar, Albany, New York, October 22.

“The Great Escape? A Quantitative Evaluation of the
Fed’s Nonstandard Policies,” Marco Del Negro and
Andrea Ferrero. With Gauti Eggertsson and Nobuhiro
Kiyotaki. Presented by Ferrero at the Centre for
Economic Policy Research/European Summer
Institute Fourteenth Annual Conference, “How Has
Our View of Central Banking Changed with the
­Recent ­Financial Crisis?” Izmir, Turkey, October 28.
­Presented by Del Negro at the European Central Bank
Conference on Monetary and Fiscal Policy Challenges
in Times of Financial Stress, Frankfurt, Germany,
December 2.

“A Life-Cycle Model of Trans-Atlantic Employment
­Experiences,” Sagiri Kitao. Rutgers University
Economics Department seminar, New Brunswick,
New Jersey, November 2. With Lars Ljungqvist and
Thomas Sargent.
“Evaluating Interest Rate Rules in an Estimated DSGE
Model,” Andrea Tambalotti. NBER workshop on
Methods and Applications for Dynamic Stochastic
General Equilibrium Models, held at the Federal
Reserve Bank of Atlanta, Atlanta, Georgia, October 1.

“Macroeconomics-Business Cycles,” Stefano Eusepi.
Conference on Labor Supply Heterogeneity and
Macroeconomic Comovement, North Carolina State
University, Raleigh, North Carolina, October 4. With
Bruce Preston.

“Household Debt and Saving during the 2007
Recession,” Wilbert van der Klaauw. CIRET (Centre
for International Research on Economic Tendency
Surveys) Conference on Economic Tendency Surveys
and the Services Sector, hosted by the Conference
Board, New York City, October 15. With Rajashri
Chakrabarti, Donghoon Lee, and Basit Zafar. Also
presented at the NBER Conference on Research in
Income and Wealth, held at the Federal Reserve
Board, Washington, D.C., November 12.

“Banking Globalization and Monetary Transmission,”
Linda Goldberg. Seminar on Banking Globalization,
Monetary Transmission, and the Lending Channel,
cosponsored by the London Business School, the
London School of Economics and Political Science,
and University College London, held at the London
School of Economics and Political Science, London,
England, November 15. With Nicola Cetorelli.
“Micro, Macro, and Strategic Forces in Invoicing
International Trade,” Linda Goldberg. Seminar cosponsored by the Paris School of Economics and Sciences
Po, Paris, France. November 16. With Cédric Tille.

“How Do College Students Form Expectations?” Basit
Zafar. CIBC Centre for Human Capital and Productivity Workshop on Post-Secondary Education,
University of Western Ontario, London, Ontario,
Canada, December 9.

“Financial Amplification of Foreign Exchange Risk
Premia,” Jan Groen. Institute for Monetary and
Economic Studies seminar, held at the Bank of Japan,
Tokyo, Japan, December 14. With Tobias Adrian and
Erkko Etula.

“Understanding Trust in a Segmented Society,” Basit
Zafar. Experimental Science Association North
American conference, Tucson, Arizona, November 13.
With Adeline Delavande. n

Recently Published
Jaison Abel. 2010. “Hedonic Price Indexes for Personal Computer Operating Systems and Productivity
Suites,” with Ernst R. Berndt, Cory W. Monroe, and
Alan G. White. Annals of Economics and Statistics
79/80, July-December: 787-807.

Sagiri Kitao. 2010. “Short-Run Fiscal Policy: Welfare,
Redistribution, and Aggregate Effects in the Short
and Long Run.” Journal of Economic Dynamics and
Control 34, no. 10 (October): 2109-25.
Donald Morgan. 2010. Comment on “Banks’ Financial Conditions and the Transmission of Monetary
Policy: A FAVAR Approach,” by Ramona Jimborean
and Jean-Stéphane Mésonnier. International Journal
of Central Banking 6, no. 4 (December): 119-24.

Tobias Adrian. 2010. “Financial Intermediaries and
Monetary Economics,” with Hyun Song Shin.
In Benjamin M. Friedman and Michael Woodford,
eds., Handbook of Monetary Economics, 3: 601-50.
Elsevier B.V.

Simon Potter. 2010. “A Flexible Approach to
Parametric Inference in Nonlinear and Time-Varying
Time Series Models,” with Gary Koop. Journal of
Econometrics 159, no. 1 (November): 134-50.

Morten Bech. 2010. “The Topology of the Federal
Funds Market,” with Enghin Atalay. Physica A:
Statistical Mechanics and Its Applications 389, no. 22
(November): 5223-46.

Ayşegül Şahin. 2010. “Labor-Market Matching with
Precautionary Savings and Aggregate Fluctuations,”
with Per Krusell and Toshihiko Mukoyama. Review of
Economic Studies 77, no. 4 (October): 1477-1507.

Carlos Carvalho. 2010. “Loss Aversion, Asymmetric
Market Comovements, and the Home Bias,” with
Kevin Amonlirdviman. Journal of International
Money and Finance 29, no. 7 (November): 1303-20.

James Vickery. 2010. “Rainfall Insurance in SemiArid India: Contract Design, Household Participation, and Future Prospects,” with Robert Townsend
and Xavier Giné. In Kenneth Tang, ed., Weather Risk
Management, 141-54. London: RiskBooks. n

Erica Groshen. 2010. Comment on “Are the New Jobs
Good Jobs?” by Katharine G. Abraham and James R.
Spletzer. In Katharine G. Abraham, James R. Spletzer,
and Michael Harper, eds., Labor in the New Economy,
143-7. NBER conference volume. Chicago: University
of Chicago Press.
Sagiri Kitao. 2010. “Labor-Dependent Capital Income
Taxation.” Journal of Monetary Economics 57, no. 8
(November): 959-74.


Research UPDATE n Number 4, 2010

Research and Statistics Group
Publications and Papers: October–December 2010

Publications are available at

No. 475, October 2010
Equity Premium Predictions with Adaptive
Macro Indexes
Jennie Bai

No. 2, October 2010
Program Design, Incentives, and Response:
Evidence from Educational Interventions
Rajashri Chakrabarti

No. 476, November 2010
Fitting Observed Inflation Expectations
Marco Del Negro and Stefano Eusepi

Policy Analysis Using DSGE Models:
An Introduction
Argia M. Sbordone, Andrea Tambalotti, Krishna Rao,
and Kieran Walsh

No. 477, November 2010
The Tri-Party Repo Market before
the 2010 Reforms
Adam Copeland, Antoine Martin, and Michael Walker

The Introduction of the TMPG Fails Charge for
U.S. Treasury Securities
Kenneth D. Garbade, Frank M. Keane, Lorie Logan,
Amanda Stokes, and Jennifer Wolgemuth

No. 478, November 2010
Double Majors: One for Me, One for the Parents?
Basit Zafar

Central Bank Dollar Swap Lines and Overseas
Dollar Funding Costs
Linda S. Goldberg, Craig Kennedy, and Jason Miu

No. 479, November 2010
An Introduction to the FRBNY Consumer
Credit Panel
Donghoon Lee and Wilbert van der Klaauw

The Federal Reserve’s Commercial Paper
­Funding Facility
Tobias Adrian, Karin Kimbrough,
and Dina Marchioni

No. 480, December 2010
The Financial Crisis at the Kitchen Table: Trends in
Household Debt and Credit
Meta Brown, Andrew Haughwout, Donghoon Lee,
and Wilbert van der Klaauw

No. 8, December 2010
Why Is the Market Share of Adjustable-Rate
Mortgages So Low?
Emanuel Moench, James Vickery, and Diego Aragon

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.