Keywords: Mortgage hedging, MBS, prepayment risk
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.
Full paper (241 KB PDF)
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Last update: September 23, 2003