The Effects of Purchases of Mortgages and Securitization By Government Sponsored Enterprises on Mortgage Yield Spreads and Volatility

In this paper, we investigate the effects of GSE (government sponsored enterprise) activities on mortgage yield spreads and volatility. Using various regression procedures (i.e., vector error correction (VEC) and GARCH models) and controlling for default and prepayment risk, we find that securitizations and purchases of mortgages by GSEs reduce mortgage yield spreads and volatility. In particular, we find that the yield spread between conforming and 10-year constant maturity treasury (CMT) rates decreases by 8.0 bp per $1 billion increase in the level of GSE securitizations. Similarly, if GSEs increase mortgage purchases, the yield spread decreases 10.5 bp per $1 billion increase of purchases. In addition, we hypothesize and find that GSE activities have a spillover effect to the non-conforming mortgage market; via investor substitutions, GSE purchases and securitizations of conforming loans reduce non-conforming loan rates. Thus, the measured influence of GSE activities is biased downward when measured using the spread of non-conforming loans over conforming loan rates. We also find that purchases of mortgages by GSEs significantly reduce mortgage yield volatility. In sum, our findings show that GSE activities reduce and stabilize mortgage market rates. Copyright 2002 by Kluwer Academic Publishers