New Strategy for Dynamically Hedging Mortgage-Backed Securities

JOURNAL OF DERIVATIVES, Vol 2 No 4

Posted: 25 May 1998

See all articles by Jacob Boudoukh

Jacob Boudoukh

Interdisciplinary Center (IDC) Herzliyah; AQR Capital Management, LLC

Richard Stanton

University of California, Berkeley - Haas School of Business

Matthew P. Richardson

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); AQR Capital Management, LLC

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

Abstract

This article develops a new approach for hedging mortgage- backed securities (MBS) that involves estimating the joint distribution returns on MBS and T-note futures, conditional on economic conditions. The resulting hedge ratio is calculated by differentially weighting past pairs of MBS and T-note futures returns, where the weights depend on how close current economic variables are to their historical values. In an out-of-sample hedging exercise, using weekly and monthly returns on 8%, 9%, and 10% GNMAs over the 1990-1994 period, the dynamic approach is very successful at hedging out interest rate risk. For example, in hedging weekly returns on 10% GNMAs, the method reduces the volatility of the return from 4.1 to 2.4 basis points, while a static method achieves only 29 basis points of residual volatility. Moreover, only 1 basis point of the volatility of the dynamically hedged return can be attributed to risk associated with U.S. Treasuries, compared to 14 basis points of interest rate risk in the statically hedged return.

JEL Classification: G12, G13, G21

Suggested Citation

Boudoukh, Jacob and Stanton, Richard H. and Richardson, Matthew P. and Whitelaw, Robert F., New Strategy for Dynamically Hedging Mortgage-Backed Securities. JOURNAL OF DERIVATIVES, Vol 2 No 4. Available at SSRN: https://ssrn.com/abstract=6514

Jacob Boudoukh (Contact Author)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Richard H. Stanton

University of California, Berkeley - Haas School of Business ( email )

Haas School of Business
545 Student Services Building #1900
Berkeley, CA 94720-1900
United States
(510) 642-7382 (Phone)
(510) 643-1412 (Fax)

Matthew P. Richardson

New York University (NYU) - Department of Finance ( email )

44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
212-998-0349 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Robert F. Whitelaw

New York University ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0338 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Abstract Views
1,645
PlumX Metrics