Asset Pricing with Cohort-Based Trading in MBS Markets
66 Pages Posted: 20 Jul 2020 Last revised: 6 Jul 2021
Date Written: June 27, 2020
Agency MBSs with diverse characteristics are traded in parallel with individualized specified pool (SP) contracts and standardized to-be-announced (TBA) contracts. This parallel trading environment has distinctive effects on MBS pricing and trading: (1) Although cheapest-to-deliver (CTD) issues are present only in TBA contracts and absent from SP trading by definition, MBS heterogeneity associated with CTD discounts affects SP returns positively, with the effect stronger for lower-value SPs; (2) High selling pressure amplifies the effects of MBS heterogeneity on SP returns; (3) Greater MBS heterogeneity dampens SP and TBA trading activities but increases their ratio.
Keywords: Cohort, Heterogeneity, Liquidity, MBS, Prepayment, TBA
JEL Classification: G12, G18, G21, E58
Suggested Citation: Suggested Citation