The Cross Section of MBS Returns

60 Pages Posted: 9 Dec 2016 Last revised: 23 Sep 2018

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: June 26, 2017

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.

Keywords: Mortgages, Mortgage Backed Securities, Prepayment, Expected Returns

JEL Classification: G12, G21, G23

Suggested Citation

Diep, Peter and Eisfeldt, Andrea L. and Richardson, Scott Anthony, The Cross Section of MBS Returns (June 26, 2017). Available at SSRN: https://ssrn.com/abstract=2882299 or http://dx.doi.org/10.2139/ssrn.2882299

Peter Diep

AQR Capital Management, LLC ( email )

2 Greenwich Plaza
Greenwich, CT
United States

Andrea L. Eisfeldt (Contact Author)

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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