Review of Financial Studies Vol. 32 No. 10 2019
Understanding Mortgage Spreads
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.
- DOI
- 10.1093/rfs/hhz004
- Volume
- 32
- Issue
- 10
- Pages
- 3799-3850
- Language
- en
- Sources
- openalex crossref