The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices
AbstractThis paper investigates the market pricing of subprime mortgage risk on the basis of data for the ABX.HE family of indices, which have become a key barometer of mortgage market conditions during the recent financial crisis. After an introduction into ABX index mechanics and a discussion of historical pricing patterns, we use regression analysis to establish the relationship between observed index returns and macroeconomic news as well as market-based proxies of default risk, interest rates, liquidity and risk appetite. The results imply that declining risk appetite and heightened concerns about market illiquidity - likely due in part to significant short positioning activity - have provided a sizeable contribution to the observed collapse in ABX prices since the summer of 2007. In particular, while fundamental factors, such as indicators of housing market activity, have continued to exert an important influence on the subordinated ABX indices, those backed by AA and AAA exposures have tended to react more to the general deterioration of the financial market environment. This provides further support for the inappropriateness of pricing models that do not sufficiently account for factors such as risk appetite and liquidity risk, particularly in periods of heightened market pressure. In addition, as related risk premia can be captured by unconstrained investors, ABX pricing patterns appear to lend support to government measures aimed at taking troubled assets off banks' balance sheets - such as the US Troubled Asset Relief Program (TARP).
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Bibliographic InfoPaper provided by Bank for International Settlements in its series BIS Working Papers with number 279.
Length: 40 pages
Date of creation: Mar 2009
Date of revision:
ABX index; mortgage-backed securities; pricing; risk premia;
Other versions of this item:
- Ingo Fender & Martin Scheicher, 2009. "The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices," Applied Financial Economics, Taylor and Francis Journals, vol. 19(24), pages 1925-1945.
- NEP-ALL-2009-04-05 (All new papers)
- NEP-RMG-2009-04-05 (Risk Management)
- NEP-URE-2009-04-05 (Urban & Real Estate Economics)
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- Thomas Flavin & Gerald P. Dwyer & Mardi Dungey, 2011.
"Systematic and Liquidity Risk in Subprime-Mortgage Backed SecuritiesM,"
Economics, Finance and Accounting Department Working Paper Series
n219-11, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
- Dungey, Mardi & Dwyer, Gerald P. & Flavin, Thomas, 2011. "Systematic and Liquidity Risk in Subprime-Mortgage Backed Securities," Working Papers 11817, University of Tasmania, School of Economics and Finance.
- Mardi Dungey & Gerald P. Dwyer & Thomas Flavin, 2011. "Systematic and liquidity risk in subprime-mortgage backed securities," Working Paper 2011-15, Federal Reserve Bank of Atlanta.
- Mardi Dungey & Gerald P. Dwyer & Thomas Flavin, 2011. "Systematic and Liquidity Risk in Subprime-Mortgage Backed Securities," CAMA Working Papers 2011-30, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
- Ingo Fender & Bernd Hayo & Matthias Neuenkirch, 2011. "Daily CDS pricing in emerging markets before and during the global financial crisis," MAGKS Papers on Economics 201139, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
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