The cross section of MBS returns
Journal
Journal of Finance
Subject
Accounting
Publishing details
Authors / Editors
Diep P;Eisfelt A;Richardson S A
Biographies
Publication Year
2021
Abstract
We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns. MBS earn risk premia as compensation for their exposure to prepayment risk. We measure prepayment risk and estimate security risk loadings using real data on prepayment forecasts vs. realizations. Estimated loadings on prepayment risk are monotonically decreasing in securities’ coupons relative to the par coupon, as predicted by the fundamental effect of prepayment on the value of bonds trading above and below par. Prepayment risks appear to be priced by specialized MBS investors. In particular, we find convincing evidence that prepayment risk prices change sign over time with the sign of a representative MBS investor’s exposure to prepayment risk.
Available on ECCH
No