Macroeconomic-Driven Prepayment Risk and the Valuation of Mortgage-Backed Securities

Mikhail Chernov; Brett R. Dunn; Francis A. Longstaff

doi:10.1093/rfs/hhx140

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Macroeconomic-Driven Prepayment Risk and the Valuation of Mortgage-Backed Securities

Mikhail Chernov¹; Brett R. Dunn²; Francis A. Longstaff³

¹ UCLA Anderson School, NBER, and CEPR · ² UCLA Anderson School · ³ UCLA Anderson School and NBER

Review of Financial Studies 2018 open access

We develop a three-factor no-arbitrage model for valuing mortgage-backed securities in which we solve for the implied prepayment function from the cross-section of market prices. This model closely fits the cross-section of mortgage-backed security prices without needing to specify an econometric prepayment model. We find that implied prepayments are generally higher than actual prepayments, providing direct evidence of significant macroeconomic-driven prepayment risk premiums in mortgage-backed security prices. We also find evidence that mortgage-backed security prices were significantly affected by Fannie Mae credit risk and the Federal Reserve’s quantitative easing programs. Received May 10, 2016; editorial decision September 22, 2017 by Editor Stijn Van Nieuwerburgh.

DOI: 10.1093/rfs/hhx140
Volume: 31 (3)
Pages: 1132-1183
Language: en
Export: BibTeX
Sources: openalex crossref