Working Paper: NBER ID: w22851
Authors: Peter Diep; Andrea L. Eisfeldt; Scott Richardson
Abstract: We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns in which MBS earn risk premia as compensation for their exposure to prepayment risk. We measure prepayment risk and estimate security risk loadings using real data on prepayment forecasts vs. realizations. Estimated loadings are monotonic in securities' coupons relative to the par coupon, as predicted by the model. Prepayment risks appear to be priced by specialized MBS investors. In particular, we find convincing evidence that prepayment risk prices change sign over time with the sign of a representative MBS investor's exposure to prepayment risk.
Keywords: Mortgage-Backed Securities; Prepayment Risk; Asset Pricing
JEL Codes: E02; G12; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| prepayment risk (G21) | pricing of prepayment risk (G19) |
| MBS investors (G21) | prepayment risk (G21) |
| market composition of discount and premium securities (G10) | pricing of prepayment risk (G19) |
| prepayment risk (G21) | expected returns on MBS (G12) |
| discount markets (G10) | prepayment risk prices (G19) |
| premium markets (D49) | prepayment risk prices (G19) |
| relative coupon characteristics (D11) | expected returns on MBS (G12) |