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 3
Number 2
2009
ResearchUpdate
Research and Statistics Group www.newyorkfed.org/research
Mark Flannery and Douglas Gale Are Newest Resident Scholars
T
he Research Group is pleased to New York’s Financial Advisory Roundtable
announce that Mark J. Flannery and since its inception in 2006 as well as a
Douglas Gale have joined its Program visiting scholar at the Bank.
for Resident Scholars for 2009-10. Professor Gale is a Silver Professor
Professor Flannery is the BankAmerica and a professor of economics at New
Eminent Scholar in Finance at the York University. He has taught at the
University of Florida’s Graduate School of London School of Economics, the
Business Administration. He has written University of Pennsylvania, and the
on a range of banking and finance topics, Massachusetts Institute of Technology.
including government regulation of the In addition to authoring and coauthor-
financial sector, the information content ing several scholarly volumes, Professor
of security prices, and asset pricing. His Gale has published on financial eco-
work has appeared in the American nomics, the microstructure of markets,
Economic Review, the Journal of Finance, and the foundations of macroeconomics
the Quarterly Journal of Economics, and and monetary economics in such jour-
the Review of Financial Studies. nals as the American Economic Review,
Professor Flannery has
served as editor of the
Also in this issue…
Journal of Money, Credit,
and Banking and as asso- Loan facility eases funding pressures
ciate editor at numerous for primary dealers . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
other finance journals. New York Fed website makes vital U.S.
He was codirector of the credit data available at local level . . . . . . . . . . . . . . . 4
Federal Deposit Insurance New in the Economic Policy Review . . . . . . . . . . . . . . . 4
Corporation’s Center for Most downloaded publications . . . . . . . . . . . . . . . . . . . 6
Financial Research and is Staff Reports: New titles. . . . . . . . . . . . . . . . . . . . . . . . . 6
president of the Financial Papers recently published by Research
Intermediation Research Group economists . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Society. Professor Flannery Papers presented at conferences . . . . . . . . . . . . . . . . . 13
has been a member of the Publications and papers: July-September. . . . . . . . . . 16
Federal Reserve Bank of
Ve ea 9 pum ■ N mber
R o ls u m rec h , U N d a tbee r 4 , u 2 0 0 6 3 , 2 0 0 9
Econometrica, and the Review of interests. Resident scholars pursue their
Financial Studies. own research agendas while participating
Professor Gale is coeditor of the fully in the Research Group’s activities.
International Journal of Central Banking. They work closely with the director of
He has served on various editorial research, contribute to policymaking
boards, including the boards of discussions, and provide intellectual
Econometrica, the Journal of Economic leadership by advising and collaborating
Theory, and the Review of Economic with the Group’s economists.
Studies. He is a fellow of the Econometric Previous resident scholars are: Mark
Society. In addition, Professor Gale is a Gertler, the Henry and Lucy Moses
former member of the Economics Professor of Economics at New York
Advisory Panel of the National Science University; Eric Ghysels, the Edward M.
Foundation, a former visiting scholar at Bernstein Distinguished Professor of
2 the Federal Reserve Bank of New York, Economics at the University of North
and former chair of New York Carolina at Chapel Hill; Nobuhiro
University’s Economics Department. Kiyotaki, professor of economics at
The Research Group established its Princeton University; John Leahy, professor
Program for Resident Scholars in 2004 of economics at New York University;
to attract to the New York Fed, for a stay Suresh M. Sundaresan, the Chase
of at least six months, outstanding Manhattan Bank Foundation Professor
researchers with an international reputa- of Financial Institutions at Columbia
tion. The scholars are selected from the Business School; and Jiang Wang, the
top academic and policy institutions in Mizuho Financial Group Professor at
areas related to the Bank’s broad policy MIT’s Sloan School of Management. ■
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
Loan Facility Eases Funding Pressures for Primary Dealers
I
n “The Federal Reserve’s Primary overwhelm the markets and drive securi-
Dealer Credit Facility” (Current Issues in ties prices down.”
Economics and Finance, vol. 15, no. 4), Adrian, Burke, and McAndrews also
authors Tobias Adrian, Christopher Burke, examine the Fed’s move to broaden the
and James McAndrews provide a detailed kinds of collateral acceptable for PDCF
examination of the conditions that loans—a step taken in September 2008,
prompted the Federal Reserve to establish when Lehman Brothers, a major partici-
an emergency lending facility for primary pant in the repo market, appeared headed
dealers—banks and securities broker-dealers for bankruptcy. Recognizing that a
that trade U.S. government and other Lehman bankruptcy would put other
securities with market participants and financial institutions at risk, including the
the Federal Reserve Bank of New York. triparty clearing banks that provide cash 3
As the authors explain, the Primary and collateral custody accounts for bor-
Dealer Credit Facility (PDCF) was created rowers and lenders in multiple-day repo
largely to ease liquidity pressures in the transactions, the Fed acted to ease fund-
“repo market”—the collateralized funding ing pressures further by expanding
market where primary dealers customarily eligible collateral to include less liquid
obtain financing for their securities securities and equities.
portfolios—after the near-failure of Bear The authors also address the moral
Stearns in March 2008. Policymakers hazard concerns raised by the PDCF—
foresaw a negative chain of consequences specifically, the notion that by offering
in which the breakdown in credit avail- the assurance of back-up financing, the
ability in this market would force large facility effectively encourages primary
numbers of market participants to sell dealers to take excessive risks in manag-
their securities. In turn, this rapid sell-off ing their funding positions. As Adrian,
would cause the prices of the securities to Burke, and McAndrews note, however,
plummet, prompting lenders to demand such concerns are offset by the fact that
higher “haircuts,” or risk premia, to hold the PDCF protects prudently managed
these securities as collateral. firms from the damaging effects of the
In this environment, the Federal risks taken by less responsible firms. In
Reserve created the PDCF as a backstop addition, a number of the larger primary
facility that provides overnight loans in dealers have merged with bank holding
exchange for a wide range of collateral. companies or transformed themselves
The injection of liquidity—and the assur- into bank holding companies since the
ance that credit is available—helped arrest Bear Stearns episode—a change that gives
the downward spiral in prices and the the Federal Reserve supervisory powers
increases in haircuts. “In practice,” the over the dealers it lends to and reduces
authors note, “the PDCF allows dealers the likelihood of moral hazard.
time to arrange other financing for their The article is available at www
assets—for example, by raising equity—or .newyorkfed.org/research/current_issues/
to sell assets at a pace that would not ci15-4.html.
Research and Statistics Group
Research Update ■ Number 3, 2009
New York Fed Website Makes Vital U.S. Credit Data Available at Local Level
T
o help local policymakers address green “heat maps” illustrate whether
mortgage delinquency and foreclosure conditions have worsened or improved
issues, the New York Fed is making over the past year. In addition, a
important information on credit conditions sequence of charts shows the likelihood
available through its public website. that subprime and alt-A mortgages will
The Bank’s U.S. Credit Conditions site roll from their current status to thirty
(data.newyorkfed.org/creditconditions) days late, from sixty to ninety days late,
offers detailed data on mortgage foreclo- or from ninety days late to foreclosure.
sures and delinquencies, bank credit card The roll rates are presented in terms of
payments, and auto and student loans. the number of mortgages likely to roll
The information, along with interactive from one status to the next and in terms
4 maps, is designed to help government of dollar volumes.
agencies, community groups, commercial The Federal Reserve considers the
institutions, and other practitioners better record rate of mortgage delinquencies
understand, monitor, and respond to and foreclosures and its impact on
local conditions associated with fore- communities to be an urgent problem.
closures and credit and mortgage The goal of the U.S. Credit Conditions
delinquencies. website is to enable a wide range of
The site offers a range of informative public and private sector decision makers
features. For example, visitors can view, to use this credit information to assist
by county, overall credit conditions and their efforts to resolve the delinquency
compare a county’s ranking within its and foreclosure problem and mitigate
state or in the United States. Red and its impact. ■
New in the Economic Policy Review
Volume 15, Number 1, July nominal Treasury securities remains a more
The Case for TIPS: An Examination cost-effective strategy. This article proposes
of the Costs and Benefits that evaluations of the TIPS program be
William C. Dudley, Jennifer Roush, more comprehensive, and instead focus on
and Michelle Steinberg Ezer the ex ante costs of TIPS issuance com-
Slightly more than a decade has passed pared with nominal Treasury issuance. The
since the introduction of the Treasury authors contend that ex ante analysis is a
Inflation-Protected Securities (TIPS) more effective way to assess the costs of
program, through which the U.S. Treasury TIPS over the long run. Furthermore,
Department issues inflation-indexed debt. relative cost calculations—whether ex post
Several studies have suggested that the or ex ante—are just one aspect of a compre-
program has been a financial disappoint- hensive analysis of the costs and benefits of
ment for the Treasury and by extension the TIPS program. TIPS issuance provides
U.S. taxpayers. Relying on ex post analysis, other benefits that should be taken into
the studies argue that the issuance of account when evaluating the program,
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
especially when TIPS are only marginally Below the Line: Estimates of Negative
more expensive or about as expensive to Equity among Nonprime Mortgage
issue as nominal Treasury securities. Borrowers
Andrew F. Haughwout and Ebiere Okah
Why Did FDR’s Bank Holiday Succeed? Measures of housing units with negative
William L. Silber equity—in which the mortgage balance
After a month-long run on American banks, exceeds the value of the collateral housing
Franklin Delano Roosevelt proclaimed a unit—have become a necessary component
Bank Holiday, beginning March 6, 1933, in crafting policies to address the current
that shut down the banking system. When foreclosure crisis. This article estimates
the banks reopened on March 13, deposi- negative equity in the U.S. nonprime
tors stood in line to return their hoarded mortgage market for 2008-09 to describe
cash. This article attributes the success of the sources of the problem and the char-
the Bank Holiday and the remarkable acteristics of borrowers in negative equity.
turnaround in the public’s confidence to The authors combine information from
the Emergency Banking Act, passed by house price indexes with data on individ- 5
Congress on March 9, 1933. Roosevelt ual loans to estimate the prevalence and
used the emergency currency provisions of magnitude of negative equity across
the Act to encourage the Federal Reserve various dimensions, including the location
to create de facto 100 percent deposit of the property and the year in which
insurance in the reopened banks. The con- the mortgage originated. They find that
temporary press confirms that the public negative equity is closely associated with
recognized the implicit guarantee and, as the time and place of mortgage origination
a result, believed that the reopened banks and with the existence of subordinate
would be safe, as the President explained liens against the property. In addition,
in his first Fireside Chat on March 12, borrowers whose mortgage is worth more
1933. Americans responded by returning than their house are twice as likely as
more than half of their hoarded cash to the borrowers in positive equity to be seriously
banks within two weeks and by bidding up delinquent, or in default, on their first-lien
stock prices by the largest ever one-day mortgage. The study also uses information
percentage price increase on March 15— derived from housing price futures con-
the first trading day after the Bank Holiday tracts to estimate the path of negative
ended. The study concludes that the Bank equity beyond 2009.
Holiday and the Emergency Banking Act of
1933 reestablished the integrity of the U.S. Articles are available at www.newyorkfed
payments system and demonstrated the .org/research/epr/2009.html.
power of credible regime-shifting policies.
Research and Statistics Group
Research Update ■ Number 3, 2009
Most Downloaded Publications
L
isted below are the most sought after SSRN website, through third-quarter 2009:
Research Group articles and papers
■ “Understanding the Securitization of
from the New York Fed’s website
Subprime Mortgage Credit,” by Adam B.
and from the Bank’s page on the
Ashcraft and Til Schuermann (Staff
Social Science Research Network site
Reports, no. 318, March 2008) –
(www.ssrn.com/link/FRB-New-York.html).
885 downloads
New York Fed website, third-quarter 2009:
■ “The Corporate Governance of
■ “Why Are Banks Holding So Many
Banks,” by Jonathan R. Macey and
Excess Reserves?” by Todd Keister
Maureen O’Hara (Economic Policy
and James McAndrews (Staff Reports,
Review, vol. 9, no. 1, April 2003) –
no. 380, July 2009) – 5,498 downloads
162 downloads
6 ■ “Understanding the Securitization of
■ “Executive Equity Compensation and
Subprime Mortgage Credit,” by Adam B.
Incentives: A Survey,” by John E. Core,
Ashcraft and Til Schuermann (Staff
Wayne R. Guay, and David F. Larcker
Reports, no. 318, March 2008) –
(Economic Policy Review, vol. 9, no. 1,
2,318 downloads
April 2003) – 145 downloads
■ “The Yield Curve as a Predictor of U.S.
For the full lists of top-ten downloads,
Recessions,” by Arturo Estrella and
visit www.newyorkfed.org/research/
Frederic S. Mishkin (Current Issues in
top_downloaded/index.html.
Economics and Finance, vol. 2, no. 7,
June 1996) – 2,270 downloads
New Titles in the Staff Reports Series
The following new staff reports are avail- changes in interest rate spreads or a
able at www.newyorkfed.org/research/ response to variations in the aggregate
staff_reports. volume of credit. The authors use a simple
DSGE (dynamic stochastic general equilib-
rium) model with credit frictions, compar-
MACROECONOMICS ing the equilibrium responses to various
AND GROWTH disturbances under the modified Taylor
rules with those under a policy that would
No. 385, August 2009
maximize average expected utility.
Credit Spreads and Monetary Policy According to the model, a spread adjust-
Vasco Cúrdia and Michael Woodford
ment can improve on the standard Taylor
Cúrdia and Woodford consider the desir- rule, but the optimal size of the adjustment
ability of modifying a standard Taylor rule is unlikely to be large, and the same type
for a central bank’s interest rate policy to of adjustment is not desirable regardless of
incorporate either an adjustment for the source of variation in credit spreads.
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
A response to credit is less likely to be specific outcomes. Zafar collects a unique
helpful, and its desirable size (and sign) is panel data set of Northwestern University
less robust to alternative assumptions about undergraduates that contains their subjec-
the nature and persistence of economic tive expectations about major-specific
disturbances. outcomes. Although students tend to be
overconfident about their future academic
performance, the author finds that they
INTERNATIONAL revise their expectations about various
No. 387, August 2009 major-specific outcomes in systematic ways.
Commodity Prices, Commodity Currencies, Furthermore, students seem to update their
and Global Economic Developments probabilistic beliefs in a manner consistent
Jan J. J. Groen and Paolo A. Pesenti with Bayesian analysis: Prior beliefs about
outcomes to be realized in college tend to
This paper seeks to produce forecasts of be fairly precise, while new information
commodity price movements that can influences prior beliefs about outcomes in
systematically improve on naïve statistical the workplace. Moreover, students who are 7
benchmarks. Groen and Pesenti revisit how more uncertain about major-specific out-
well changes in commodity currencies per- comes in the initial survey make greater
form as potential efficient predictors of absolute revisions in their beliefs in the
commodity prices, a view emphasized in follow-up survey. Finally, Zafar presents
the recent literature. They also consider evidence that learning plays a role in the
different types of factor-augmented models decision to switch majors.
that use information from a large data set
containing a variety of indicators of supply No. 379, July 2009
and demand conditions across major devel- Do Vouchers Lead to Sorting under
oped and developing countries. These Random Private-School Selection?
models use either standard principal com- Evidence from the Milwaukee
ponents or the more novel partial least Voucher Program
squares (PLS) regression to extract dynam- Rajashri Chakrabarti
ic factors from the data set. The authors This paper analyzes the effect of school
consider ten alternative indices and sub- vouchers on student sorting and whether
indices of spot prices for three different vouchers can be designed to reduce or
commodity classes across different periods. eliminate it. Chakrabarti focuses on two
They find that of all the approaches, the crucial requirements of the Milwaukee
exchange-rate–based model and the PLS voucher program: 1) private schools must
factor-augmented model are more likely select students randomly and 2) private
to outperform the naïve statistical bench- schools must accept the voucher amount as
marks, although PLS factor-augmented full tuition payment (that is, “topping up”
models usually have a slight edge over the of vouchers is not permitted). Using a theo-
exchange-rate–based approach. retical model, she argues that random
selection alone cannot prevent student
sorting. However, random selection without
MICROECONOMICS topping up can preclude sorting by income,
although there is still sorting by ability.
No. 378, July 2009
Sorting by ability is not caused here by
How Do College Students Form private-school selection, but by parental
Expectations? self-selection. Examining the first five years
Basit Zafar
of the Milwaukee program, the author
This paper focuses on how college students establishes that random selection has taken
form expectations about various major- place, providing an appropriate setting for
Research and Statistics Group
Research Update ■ Number 3, 2009
testing the corresponding theoretical pre- knowledge requirements. Further, by
dictions in the data. She demonstrates that analyzing co-agglomeration patterns,
these predications are validated empirically. the authors find that occupations with
similar knowledge requirements tend
No. 383, August 2009 to co-agglomerate. Both results provide
Gender and the Availability of Credit new evidence on the importance of
to Privately Held Firms: Evidence from labor market pooling as a determinant
the Surveys of Small Business Finances of occupational agglomeration.
Rebel A. Cole and Hamid Mehran
Using data from the nationally representa- No. 394, September 2009
tive Surveys of Small Business Finances, The Dynamics of Automobile Expenditures
Cole and Mehran document empirical Adam Copeland
regularities in male- and female-owned This paper presents a dynamic model for
firms. They find that female-owned firms light motor vehicles. Consumers solve an
are 1) significantly smaller, as measured by optimal stopping problem in deciding if
8 sales, assets, and employment; 2) younger, they want a new automobile and when in
as measured by age of the firm; 3) more the model year to purchase it. This dynamic
likely to be organized as proprietorships approach allows for determining how the
and less as corporations; 4) more likely to mix of consumers evolves over the model
be in retail trade and business services; and year and for measuring consumers’ substi-
5) inclined to have fewer and shorter bank- tution patterns across products and time.
ing relationships. Moreover, female owners Copeland finds that temporal substitution
are significantly younger, less experienced, is significant, driving consumers’ entry into
and not as well educated. The authors also and exit from the market. Through counter-
find strong univariate evidence that female- factuals, he shows that because consumers
owned firms are significantly more likely to will temporarily substitute to a large degree,
be credit-constrained because they are failure to account for automakers’ dynamic
more likely to be discouraged from apply- pricing strategies results in an inaccurate
ing for credit, though not more likely to be picture of the return to using pricing incen-
denied credit when they do apply. However, tives. A further finding is that the large
any differences are rendered insignificant price discounts typically offered at the end
in a multivariate setting, which controls for of the model year result in price discrimina-
other firm and owner characteristics. tion by inducing price-sensitive consumers
to delay purchasing new vehicles until the
No. 392, September 2009 later months of the model year.
Labor Market Pooling and Occupational
Agglomeration
Todd M. Gabe and Jaison R. Abel BANKING AND FINANCE
This paper examines the micro-foundations
of occupational agglomeration in U.S. metro- No. 380, July 2009
politan areas, with an emphasis on labor Why Are Banks Holding So Many
market pooling. Controlling for a wide Excess Reserves?
Todd Keister and James McAndrews
range of occupational attributes, including
proxies for the use of specialized machin- The quantity of reserves in the U.S. banking
ery and for the importance of knowledge system has risen dramatically since
spillovers, Gabe and Abel find that jobs September 2008. Some commentators have
characterized by a unique knowledge base expressed concern that this pattern indi-
exhibit higher levels of geographic concen- cates that the Federal Reserve’s liquidity
tration than do occupations with generic facilities have been ineffective in promoting
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
the flow of credit to firms and households. securitization of assets and the integration
Others have argued that the high level of of banking with capital market develop-
reserves will be inflationary. Keister and ments. This trend has been most pro-
McAndrews explain, through a series of nounced in the United States, but it has
examples, why banks are currently holding had a profound influence on the global
so many reserves. The examples show how financial system. In a market-based finan-
the quantity of bank reserves is determined cial system, banking and capital market
by the size of the Federal Reserve’s policy developments are inseparable: Funding
initiatives and in no way reflects the initia- conditions are closely tied to fluctuations
tives’ effects on bank lending. They also in the leverage of market-based financial
argue that a large increase in bank reserves intermediaries. Growth in the balance
need not be inflationary, because the sheets of these intermediaries provides a
payment of interest on reserves allows the sense of the availability of credit, while
Federal Reserve to adjust short-term contractions of the balance sheets have
interest rates independently of the level tended to precede the onset of financial
of reserves. crises. Securitization was intended as a way 9
to transfer credit risk to those better able
No. 381, July 2009 to absorb losses, but instead it increased
The Microstructure of a U.S. Treasury the fragility of the entire financial system
ECN: The BrokerTec Platform by allowing banks and other intermediaries
Michael J. Fleming and Bruce Mizrach to “leverage up” by buying one another’s
This paper assesses the microstructure of securities. In the new, post-crisis financial
the U.S. Treasury securities market, using system, the role of securitization will likely
newly available tick data from the be held in check by more stringent finan-
BrokerTec electronic trading platform. cial regulation and by the recognition that
Examining trading activity, bid-ask spreads, it is important to prevent excessive leverage
and depth for on-the-run two-, three-, five-, and maturity mismatch, both of which can
ten-, and thirty-year Treasury securities, undermine financial stability.
Fleming and Mizrach find that market liq-
uidity is greater than that found in earlier No. 384, August 2009
studies that use data only from voice- Prestigious Stock Exchanges: A Network
assisted brokers. They find that the price Analysis of International Financial Centers
effect of trades on BrokerTec is quite small Nicola Cetorelli and Stavros Peristiani
and is even smaller once order-book This study uses methods from social
information is considered. Moreover, order- network analysis to assess the relative
book information itself is shown to affect importance of financial centers around the
prices. The authors also explore a novel world. The first phase of the analysis evalu-
feature of BrokerTec—the ability to enter ates international stock exchanges based
hidden (“iceberg”) orders—and find that, as on their ability to attract global initial
predicted by theory, such orders are more public offerings (IPOs). The second phase
common when price volatility is higher. compares the capacity of these exchanges
to provide an efficient trading platform
No. 382, July 2009 for cross-listed companies. Cetorelli and
The Shadow Banking System: Implications Peristiani find that despite a diminished
for Financial Regulation ability to attract cross-border IPOs, U.S.
Tobias Adrian and Hyun Song Shin
exchanges have maintained an undis-
The current financial crisis has highlighted putable lead in global equity activity
the growing importance of the “shadow throughout the entire sample period. They
banking system,” which grew out of the do find evidence of the rising importance
Research and Statistics Group
Research Update ■ Number 3, 2009
of competing exchanges—in particular, the cost of bank capital that is traded off
London Stock Exchange, the Deutsche against the benefits of capital: strengthened
Börse, and the Hong Kong Stock Exchange— incentives for the bank to engage in value-
and of an expanding role for a number of enhancing loan monitoring and a higher
emerging market stock exchanges. However, probability of avoiding regulatory closure
this rising pattern reflects improved due to loan delinquencies. The model
competitive conditions in a growing global predicts that 1) the total value of the bank
market rather than a sudden decline in and its equity capital are positively correlated
the activity of U.S. exchanges. in the cross section and 2) the various
components of bank value are also posi-
No. 389, September 2009 tively cross-sectionally related to bank
Liquidity Risk, Credit Risk, and the Federal capital. When the authors confront the
Reserve’s Responses to the Crisis predictions with the data on bank acquisi-
Asani Sarkar tions, they find strong support. Their results
In responding to the severity and broad are robust to a variety of alternative
10 scope of the financial crisis that began in explanations.
2007, the Federal Reserve has made
No. 391, September 2009
aggressive use of both traditional monetary
policy instruments and innovative tools in
Price-Increasing Competition:
an effort to provide liquidity. Sarkar
The Curious Case of Overdraft versus
examines the Fed’s actions in light of the
Deferred Deposit Credit
Brian T. Melzer and Donald P. Morgan
underlying financial amplification mecha-
nisms propagating the crisis—in particular, The authors find that banks charge more
balance sheet constraints and counterparty for overdraft credit when depositors have
credit risk. The empirical evidence access to a potential substitute: deferred
supports the Fed’s views on the primacy deposit (“payday”) credit. They attribute
of balance sheet constraints in the earlier this rise in prices partly to adverse selec-
stages of the crisis and the increased tion created by banks’ practice of charging
prominence of counterparty credit risk as a flat fee regardless of the overdraft
the crisis evolved in 2008. The author amount—pricing that favors depositors
concludes that an understanding of the prone to large overdrafts. When deferred
prevailing risk environment is necessary deposit credit priced per dollar borrowed is
in order to evaluate when central bank available, depositors prone to small over-
programs are likely to be effective and drafts switch to that option. That selection
under what conditions the programs might works against banks; large overdrafts cost
cease to be necessary. more to supply and, if depositors default,
banks lose more, so prices rise. Consistent
No. 390, September 2009 with this adverse-selection hypothesis,
Bank Capital and Value in Melzer and Morgan document that the
the Cross Section average dollar amount per returned check
Hamid Mehran and Anjan Thakor
at banks and other depository institutions
Mehran and Thakor address two questions: increases when depositors have access to
1) Are bank capital structure and value deferred deposit credit. Beyond document-
correlated in the cross section, and if so, ing another case of price-increasing com-
how? 2) If bank capital does affect bank petition, their findings bear on theories of
value, how are the components of bank adverse selection in credit markets and
value affected by capital? The authors first contribute to the debate over the pros and
develop a dynamic model with a dissipative cons of payday credit.
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
No. 393, September 2009 thirty-year U.S. Treasury futures to investi-
Capital Constraints, Counterparty Risk, gate the role of the market maker. Most
and Deviations from Covered Interest theory characterizes the market maker as
Rate Parity an uninformed, passive supplier of liquidity.
Niall Coffey, Warren Hrung, and Asani Sarkar Their findings suggest, however, that some
Coffey, Hrung, and Sarkar provide robust market makers actively demand liquidity
evidence of a deviation in the covered for a substantial part of the day and that
interest rate parity (CIP) relation since they are informed speculators.
the onset of the financial crisis in August
2007. The deviation exists with respect to QUANTITATIVE METHODS
various dollar-denominated interest rates
and exchange rate pairings of the dollar No. 386, August 2009
vis-à-vis other currencies. The authors Parsimonious Estimation with
show that their proxies for margin condi- Many Instruments
tions and for the cost of capital are signifi- Jan J. J. Groen and George Kapetanios
11
cant determinants of the CIP deviations, Groen and Kapetanios suggest a way to
especially during the crisis period. The perform parsimonious instrumental
supply of dollars by the Federal Reserve variables estimation in the presence of
to foreign central banks via reciprocal many, and potentially weak, instruments.
currency arrangements (swap lines) In contrast to standard methods, the
reduced CIP deviations at this time. authors’ approach yields consistent esti-
Following the bankruptcy of Lehman mates when the set of instrumental
Brothers, uncertainty about counterparty variables complies with a factor structure.
risk became a significant determinant In this sense, their method is equivalent to
of CIP deviations, and the swap lines instrumental variables estimation that is
program no longer affected the deviations based on principal components. However,
significantly. These results indicate a even if the factor structure is weak or
breakdown of arbitrage transactions in nonexistent, the authors’ method, unlike
the international capital markets that the principal components approach, still
owes partly to lack of capital and partly yields consistent estimates. Indeed, simula-
to heightened counterparty credit risk. tions indicate that their approach always
dominates standard instrumental variables
No. 395, September 2009 estimation, regardless of whether the factor
Are Market Makers Uninformed and relationship underlying the set of instru-
Passive? Signing Trades in the Absence ments is strong, weak, or absent.
of Quotes
Michel van der Wel, Albert J. Menkveld, No. 388, August 2009
and Asani Sarkar Real-Time Inflation Forecasting
This study develops a new likelihood-based in a Changing World
approach to signing trades in the absence Jan J. J. Groen, Richard Paap,
and Francesco Ravazzolo
of quotes. The approach is equally efficient
as the existing Markov-chain Monte Carlo The authors propose a Phillips-curve–type
methods, but more than ten times faster. model that results from averaging across
It can address the occurrence of multiple different regression specifications selected
trades at the same time and allows for from a set of potential predictors. In each
analysis of settings in which trade times are specification, they allow for stochastic
observed with noise. The authors apply this breaks in regression parameters, where the
method to a high-frequency data set of breaks are described as occasional shocks
Research and Statistics Group
Research Update ■ Number 3, 2009
of random magnitude. As such, their breaks across different combinations of
framework simultaneously addresses struc- activity measures. These breaks often
tural change and model uncertainty that coincide with policy regime changes and
unavoidably affect Phillips-curve–based oil price shocks, among other important
predictions. Groen, Paap, and Ravazzolo events. In contrast to many previous
use this framework to describe personal studies, the authors find less evidence of
consumption expenditure (PCE) deflator autonomous variance breaks and inflation
and GDP deflator inflation rates for the gap persistence. They also show that their
United States in the post–World War II model specification generally provides
period. Over the full 1960-2008 sample, superior one-quarter-ahead and one-year-
the framework indicates several structural ahead forecasts for quarterly inflation. ■
12
Recently Published
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Beta: Time-Varying Factor Loadings, Coordination Failures: An Experimental
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of Japan seminar, Tokyo, Japan, July 10. Rebecca Barros, Marco Bonomo, and
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Research and Statistics Group
Research Update ■ Number 3, 2009
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14 Massachusetts, July 9. With Ricardo Reis. Econometric Institute Seminar Series,
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European Economic Association and Financial Fragility, University Park,
the Econometric Society European Pennsylvania, September 26.
Meeting, Barcelona, Spain, August 25.
With Bruce Preston. “Banking Panics and Policy Responses,”
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Rules,” Andrea Ferrero. Joint Congress Texas, September 21. Also presented at a
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Del Negro and Gauti Eggertsson.
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Germany, September 9. Hrung, and Hoai-Luu Nguyen. Also
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European Economic Association and the
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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
www.newyorkfed.org/research
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Ashcraft and Paul Goldsmith-Pinkham.
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Future,” Charles Steindel. An Ocean Apart? and Financial Market Risk, Cambridge,
Comparing Transatlantic Responses to the Massachusetts, July 8; the American
Financial Crisis, a conference sponsored by Real Estate and Urban Economics
the Bank of Italy and the Peterson Institute Association/Asian Real Estate Society
for International Economics, Rome, Italy, International Conference, University of
September 10. California at Los Angeles, Los Angeles,
California, July 12; the Centre for
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of Investment,” Andrea Tambalotti. Society Gerzensee European Summer Symposium 15
for Economic Dynamics annual meeting, in Financial Markets, Gerzensee,
Istanbul, Turkey, July 3. With Alejandro Switzerland, July 22; a U.S. Securities
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Washington, D.C., August 20; and the
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Inflation Expectations: Preliminary Research in Finance conference Business
Findings,” Wilbert Van der Klaauw. Models in Banking: Is There a Best Practice?
Reserve Bank of India seminar, Mumbai, Milan, Italy, September 21. ■
India, July 2. With Wändi Bruine de Bruin,
Michael Bryan, Simon Potter, and
Giorgio Topa.
Research and Statistics Group
Research Update ■ Number 3, 2009
Research and Statistics Group CURRENT ISSUES IN
ECONOMICS AND FINANCE,
Publications and Papers: VOL. 15
July-September 2009
Number 3, July 2009
Publications are available at Productivity Swings and Housing Prices
www.newyorkfed.org/research/ James A. Kahn
publication_annuals/index.html. Number 4, August 2009
The Federal Reserve’s Primary Dealer
ECONOMIC POLICY REVIEW, Credit Facility
VOL. 15 Tobias Adrian, Christopher R. Burke,
and James J. McAndrews
Number 1, July 2009 Number 5, September 2009
Is the Worst Over? Economic Indexes
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16 of the Costs and Benefits in New York and New Jersey
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Special Issue: Central Bank Liquidity No. 379, July 2009
Tools and Perspectives on Regulatory Do Vouchers Lead to Sorting under
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Evidence from the Milwaukee
Central Bank Tools and Liquidity Voucher Program
Shortages Rajashri Chakrabarti
Stephen G. Cecchetti and Piti Disyatat
No. 380, July 2009
Provision of Liquidity through the Why Are Banks Holding So Many
Primary Credit Facility during the Excess Reserves?
Financial Crisis: A Structural Analysis Todd Keister and James McAndrews
Erhan Artuç and Selva Demiralp
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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
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The Shadow Banking System: Liquidity Risk, Credit Risk, and the Federal
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No. 383, August 2009 No. 390, September 2009
Gender and the Availability of Credit Bank Capital and Value in
to Privately Held Firms: Evidence from the Cross Section
the Surveys of Small Business Finances Hamid Mehran and Anjan Thakor
Rebel A. Cole and Hamid Mehran No. 391, September 2009
No. 384, August 2009 Price-Increasing Competition:
Prestigious Stock Exchanges: The Curious Case of Overdraft
A Network Analysis of International versus Deferred Deposit Credit
Financial Centers Brian T. Melzer and Donald P. Morgan
Nicola Cetorelli and Stavros Peristiani No. 392, September 2009
No. 385, August 2009 Labor Market Pooling and 17
Credit Spreads and Monetary Policy Occupational Agglomeration
Vasco Cúrdia and Michael Woodford Todd M. Gabe and Jaison R. Abel
No. 386, August 2009 No. 393, September 2009
Parsimonious Estimation with Capital Constraints, Counterparty Risk,
Many Instruments and Deviations from Covered Interest
Jan J. J. Groen and George Kapetanios Rate Parity
No. 387, August 2009 Niall Coffey, Warren Hrung, and Asani Sarkar
Commodity Prices, Commodity No. 394, September 2009
Currencies, and Global Economic The Dynamics of Automobile Expenditures
Developments Adam Copeland
Jan J. J. Groen and Paolo A. Pesenti No. 395, September 2009
No. 388, August 2009 Are Market Makers Uninformed
Real-Time Inflation Forecasting and Passive? Signing Trades in
in a Changing World the Absence of Quotes
Jan J. J. Groen, Richard Paap, Michel van der Wel, Albert J. Menkveld,
and Francesco Ravazzolo and Asani Sarkar
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