Mortgage Risk and the Yield Curve
The Review of Financial Studies, Forthcoming
50 Pages Posted: 21 Mar 2013 Last revised: 23 Jan 2016
Date Written: January 22, 2016
We study feedback from the risk of outstanding mortgage-backed securities (MBS) on the level and volatility of interest rates. We incorporate supply shocks resulting from changes in MBS duration into a parsimonious equilibrium dynamic term structure model and derive three predictions that are strongly supported in the data: (1) MBS duration positively predicts nominal and real excess bond returns, especially for longer maturities; (2) the predictive power of MBS duration is transitory in nature; and (3) MBS convexity increases interest rate volatility, and this effect has a hump-shaped term structure.
Keywords: Term Structure of Interest Rates, MBS, Supply Factor
JEL Classification: E43, G11, G12, G21
Suggested Citation: Suggested Citation