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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Does Mortgage Hedging Amplify Movements in Long-term Interest Rates?
Roberto Perli and Brian Sack

Abstract: The growth of the mortgage market in recent years has raised the question of what effects, if any, the hedging of mortgage portfolios has on the behavior of long-term interest rates. This paper finds that the volatility of the ten-year swap rate implied by swaptions increases when the prepayment risk of outstanding mortgages increases--most likely because investors expect the hedging of prepayment risk to amplify future interest rate movements. These amplification effects can be considerable in magnitude, but they are generally expected to persist only for several months.

Keywords: Mortgage hedging, MBS, prepayment risk

Full paper (241 KB PDF)

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Last update: September 23, 2003