Mortgage Risk and the Yield Curve

Aytek Malkhozov; Philippe Mueller; Andrea Vedolin; Gyuri Venter

doi:10.1093/rfs/hhw003

Mortgage Risk and the Yield Curve

Aytek Malkhozov, Philippe Mueller, Andrea Vedolin, Gyuri Venter

Department of Finance

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Abstract

We study feedback from the risk of outstanding mortgage-backed securities (MBS) on the level and volatility of interest rates. We incorporate supply shocks resulting from changes in MBS duration into a parsimonious equilibrium dynamic term structure model and derive three predictions that are strongly supported in the data: (1) MBS duration positively predicts nominal and real excess bond returns, especially for longer maturities; (2) the predictive power of MBS duration is transitory in nature; and (3) MBS convexity increases interest rate volatility, and this effect has a hump-shaped term structure.

Original language	English
Journal	The Review of Financial Studies
Volume	29
Issue number	5
Pages (from-to)	1220-1253
Number of pages	34
ISSN	0893-9454
DOIs	https://doi.org/10.1093/rfs/hhw003
Publication status	Published - 2016

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AB - We study feedback from the risk of outstanding mortgage-backed securities (MBS) on the level and volatility of interest rates. We incorporate supply shocks resulting from changes in MBS duration into a parsimonious equilibrium dynamic term structure model and derive three predictions that are strongly supported in the data: (1) MBS duration positively predicts nominal and real excess bond returns, especially for longer maturities; (2) the predictive power of MBS duration is transitory in nature; and (3) MBS convexity increases interest rate volatility, and this effect has a hump-shaped term structure.

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