Asset Pricing with Cohort-Based Trading in MBS Markets
53 Pages Posted: 7 Jul 2020 Last revised: 11 Aug 2020
Date Written: July 1, 2020
Agency mortgage-backed securities (MBS) with diverse characteristics are traded in parallel with individualized contracts in the speciﬁed pool (SP) market and with standardized contracts in the to-be-announced (TBA) market. We ﬁnd that this unique parallel trading environment substantially affects MBS returns: (1) Greater heterogeneity in MBS values increases the yields of all MBS because it exacerbates the cheapest-to-deliver concerns for TBA buyers and reduces the value of the TBA market as a backup selling venue for SP buyers; (2) high selling pressure ampliﬁes the impact of MBS heterogeneity on MBS yields; (3) greater MBS heterogeneity dampens trading activities on both the SP and TBA markets and increases the ratio between the two. We provide strong evidence that these effects differ from the impacts of prepayment risks.
Keywords: cohort, heterogeneity, liquidity, MBS, prepayment, TBA
JEL Classification: E58, G12, G18, G21
Suggested Citation: Suggested Citation