Agency MBS as Safe Assets

Abstract

Measured as yield spreads against AAA corporate bonds, the convenience premium for agency MBS averaged 47 basis points between 1995 and 2021, about half of the long-term-Treasury convenience premium. Both the MBS convenience premium and the issuance amount vary negatively with the mortgage rate, which is consistent with a prepayment-driven demand channel. This negative dependence contrasts strikingly with the positive dependence of the MBS-repo convenience premium on interest rates, as implied by the “opportunity cost of money” hypothesis. The placing of agencies into conservatorship in 2008 and the introduction of the liquidity coverage ratio in 2013 affected the convenience premium significantly, which is consistent with the safety and regulatory-constraint channels of demand for MBS. Based on “structural” restrictions in standard models, the ratio of MBS to Treasury convenience premia pinpoints the time-varying MBS-specific demand empirically.