Asset Pricing with Cohort-Based Trading in MBS Markets
67 Pages Posted: 7 Jul 2020 Last revised: 11 Aug 2021
Date Written: July 1, 2020
Agency MBSs with diverse characteristics are traded in parallel through individualized specified pool (SP) contracts and standardized to-be-announced (TBA) contracts. This parallel trading environment generates distinctive effects on MBS pricing and trading: (1) Although cheapest-to-deliver (CTD) issues are present in TBA trading and absent from SP trading by design, 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: E58, G12, G18, G21
Suggested Citation: Suggested Citation