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Understanding Mortgage Spreads

Nina Boyarchenko1; Andreas Fuster2; David O. Lucca1

1 Federal Reserve Bank of New York · 2 Swiss National Bank

Review of Financial Studies 2019 open access

Abstract Because most mortgages in the United States are securitized in agency mortgage-backed securities (MBS), yield spreads on MBS are a key determinant of homeowners’ funding costs. We study variation in MBS spreads in the time series and across securities and document that MBS spreads show a pronounced cross-sectional smile with respect to the securities’ coupon rates. We present a new pricing model that uses “stripped” MBS prices to identify the contribution of non-interest-rate prepayment risk to spreads and find that this risk explains the smile, whereas the time-series spread variation is mostly accounted for by nonprepayment risk factors. Received March 30, 2015; editorial decision November 21, 2018 by Editor Leonid Kogan. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

DOI
10.1093/rfs/hhz004
Volume
32 (10)
Pages
3799-3850
Language
en
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