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Does mortgage hedging amplify movements in long-term interest rates?

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Author Info

  • Roberto Perli
  • 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.

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File URL: http://www.federalreserve.gov/pubs/feds/2003/200349/200349abs.html
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File URL: http://www.federalreserve.gov/pubs/feds/2003/200349/200349pap.pdf
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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2003-49.

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Date of creation: 2003
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Handle: RePEc:fip:fedgfe:2003-49

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Keywords: Mortgages ; Mortgage loans;

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  1. Dwight Jaffee, 2003. "The Interest Rate Risk of Fannie Mae and Freddie Mac," Journal of Financial Services Research, Springer, vol. 24(1), pages 5-29, August.
  2. John Kambhu & Patricia C. Mosser, 2001. "The effect of interest rate options hedging on term-structure dynamics," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 51-70.
  3. Julia Fernald & Patricia C. Mosser & Frank Keane, 1994. "Mortgage security hedging and the yield curve," Research Paper 9411, Federal Reserve Bank of New York.
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Citations

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Cited by:
  1. Sabrina R. Pellerin & Steven J. Sabol & John R. Walter, 2013. "mREITs and their risks," Working Paper 13-19, Federal Reserve Bank of Richmond.
  2. Andreas Lehnert & Wayne Passmore & Shane M. Sherlund, 2006. "GSEs, mortgage rates, and secondary market activities," Finance and Economics Discussion Series 2006-30, Board of Governors of the Federal Reserve System (U.S.).
  3. Quigley, John M., 2006. "Federal Credit and Insurance Programs: Housing," Berkeley Program on Housing and Urban Policy, Working Paper Series qt41d5k3bd, Berkeley Program on Housing and Urban Policy.
  4. Feldhütter, Peter & Lando, David, 2008. "Decomposing swap spreads," Journal of Financial Economics, Elsevier, vol. 88(2), pages 375-405, May.
  5. W. Scott Frame & Lawrence J. White, 2005. "Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?," Journal of Economic Perspectives, American Economic Association, vol. 19(2), pages 159-184, Spring.
  6. Robert Eisenbeis & W. Frame & Larry Wall, 2007. "An Analysis of the Systemic Risks Posed by Fannie Mae and Freddie Mac and An Evaluation of the Policy Options for Reducing Those Risks," Journal of Financial Services Research, Springer, vol. 31(2), pages 75-99, June.
  7. Hancock, Diana & Passmore, Wayne, 2011. "Did the Federal Reserve's MBS purchase program lower mortgage rates?," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 498-514.
  8. Wall, Larry D. & Eisenbeis, Robert A. & Frame, W. Scott, 2005. "Resolving large financial intermediaries: Banks versus housing enterprises," Journal of Financial Stability, Elsevier, vol. 1(3), pages 386-425, April.
  9. Sergey V. Chernenko, 2004. "The information content of forward and futures prices: market expectations and the price of risk," International Finance Discussion Papers 808, Board of Governors of the Federal Reserve System (U.S.).
  10. Angela Maddaloni & Darren Pain, 2004. "Corporate ‘excesses’ and financial market dynamics," Occasional Paper Series 17, European Central Bank.

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