Interest Rate Risk, Prepayment Risk and Banks’ Securitization of Mortgages

Posted: 9 Mar 2021 Last revised: 22 Feb 2022

Date Written: December 1, 2020

Abstract

This paper shows the importance of interest rate risk and prepayment risk in fixed-rate mortgages in influencing banks’ securitization of mortgages. Banks with longer-maturity liabilities are more capable of taking the interest rate risk and therefore securitize fewer mortgages. In contrast, banks with shorter-maturity liabilities securitize more mortgages and originate fewer jumbo mortgages, which can not be securitized through Fannie Mae and Freddie Mac. Moreover, household mortgage refinancing induces prepayment risk. The prepayment risk matters more for banks with longer-maturity liabilities, due to their high retention of mortgages on balance sheets. Ex ante, anticipating the prepayment risk, banks with longer-maturity liabilities securitize more mortgages. Ex post, banks with longer-maturity liabilities are less likely to help households refinance their existing mortgages.

Keywords: Banks, Interest Rate Risk, Prepayment Risk, Mortgage Securitization, Mortgage Refinancing.

JEL Classification: E43, E50, G18, G21, R20, R30

Suggested Citation

Xiao, Zhanbing, Interest Rate Risk, Prepayment Risk and Banks’ Securitization of Mortgages (December 1, 2020). Available at SSRN: https://ssrn.com/abstract=3761540 or http://dx.doi.org/10.2139/ssrn.3761540

Zhanbing Xiao (Contact Author)

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

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