Mortgage Risk and the Yield Curve
53 Pages Posted: 15 Dec 2015
Date Written: December 2015
We study the feedback from the risk of outstanding mortgage-backed securities (MBS) on the level and volatility of interest rates. We incorporate the 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: (i) MBS duration positively predicts nominal and real excess bond returns, especially for longer maturities; (ii) the predictive power of MBS duration is transitory in nature; and (iii) MBS convexity increases interest rate volatility, and this effect has a hump-shaped term structure.
The appendix for this paper can be found at http://ssrn.com/abstract=2703808.
Keywords: Term structure of interest rates, MBS, supply factor
JEL Classification: G12, G21, E43
Suggested Citation: Suggested Citation