Mortgage Risk and the Yield Curve

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

Malkhozov, Aytek and Mueller, Philippe and Vedolin, Andrea and Venter, Gyuri, Mortgage Risk and the Yield Curve (December 2015). BIS Working Paper No. 532, Available at SSRN: https://ssrn.com/abstract=2703475