Managing Mortgage Interest‐Rate Risks in Forward, Futures, and Options Markets

This article reviews the Housing Commission's perspective and recommendations on management of interest‐rate risks in housing finance, and considers the relative advantages of various techniques by which institutions on the supply side of mortgage markets can absorb or shift such risks. It is argued that exchange‐based options can provide a more reliable way than cash forward contracting for originators or purchasers of mortgages to manage commitment‐period risk, but that commitment fees charged household borrowers should not fully correspond to premiums for put options “traded” on the exchanges. It also is argued that exchange‐based futures can provide a more effective and economical way than asset‐liability maturity matching in cash markets for thrift institutions to manage portfolio interest‐rate risks; in particular, futures trading can permit these institution to meet the maturity preferences of liquidity‐conscious creditors and risk‐averse borrowers, to reduce the risk associated with unexpected shifts of the yield curve, and to maintain a higher degree of asset quality. The capacity of futures markets to handle large‐scale hedging by mortgage market participants will depend upon heavy participation by highly leveraged speculators who are willing to take long positions without the receipt of substantial risk premiums from hedgers.