Prepayment Risk and Expected MBS Returns

49 Pages Posted: 21 Nov 2016

See all articles by Peter Diep

Peter Diep

AQR Capital Management, LLC

Andrea L. Eisfeldt

UCLA Anderson School of Management

Scott A. Richardson

AQR Capital Management, LLC; London Business School

Multiple version iconThere are 2 versions of this paper

Date Written: November 2016

Abstract

We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns in which 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 are monotonic in securities' coupons relative to the par coupon, as predicted by the model. 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.

Suggested Citation

Diep, Peter and Eisfeldt, Andrea L. and Richardson, Scott Anthony, Prepayment Risk and Expected MBS Returns (November 2016). NBER Working Paper No. w22851. Available at SSRN: https://ssrn.com/abstract=2873324

Peter Diep (Contact Author)

AQR Capital Management, LLC ( email )

2 Greenwich Plaza
Greenwich, CT
United States

Andrea L. Eisfeldt

UCLA Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

HOME PAGE: http://https://sites.google.com/site/andrealeisfeldt/

Scott Anthony Richardson

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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