The Real Effects of Secondary Market Trading Structure: Evidence from the Mortgage Market
51 Pages Posted: 10 May 2019
Date Written: April 29, 2019
A vast majority of mortgages in the U.S. are securitized into agency mortgage-backed securities (MBS), many of which are traded in the to-be-announced (TBA) forward market. By allowing different MBS to be traded based on a limited set of characteristics, TBA market generates liquidity, with the aggregate daily trading volume second only to the U.S. Treasury market. In this paper, we quantify the effect of the unique secondary market trading structure on individual borrowers’ mortgage rates, demand for mortgages, and consumer spending. With a simple model, we show that the benefit of access to the TBA market is higher for loans with less desirable prepayment characteristics. Then, exploiting sharp discontinuities in the probability of a loan to be included in an MBS eligible for TBA delivery, we estimate that TBA eligibility reduces mortgage rates by 10-40 basis points, depending on the prepayment risk of the loan. Furthermore, we also provide evidence that TBA eligibility affects borrowers’ refinancing decisions and subsequent durable consumption.
Keywords: mortgage-backed securities, liquidity, primary market, TBA trades, refinancing, mortgages, consumption
JEL Classification: E21, G10, G21
Suggested Citation: Suggested Citation