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The predictive strength of MBS yield spreads during asset bubbles

Author

Listed:
  • Solomon Y. Deku

    (Nottingham Trent University)

  • Alper Kara

    (University of Huddersfield)

  • Artur Semeyutin

    (Coventry University)

Abstract

We examine whether the predictive power of initial yield spreads of mortgage-backed securities (MBS) vary with the financial cycle. Using a cross-country sample of 4203 MBS, we find that initial yield spreads of MBS incorporate more information than credit ratings and predict future downgrades, even after conditioning on initial credit ratings. Predictive power of spreads is higher during credit and housing bubbles and for the least risky AAA-rated MBS. We find that initial yield spreads capture the magnitude of rating downgrades, especially during asset bubble periods. As a novel approach in this literature, we also utilise machine learning techniques (regression trees, naïve Bayes, support vector machines and random forests) to confirm our results.

Suggested Citation

  • Solomon Y. Deku & Alper Kara & Artur Semeyutin, 2021. "The predictive strength of MBS yield spreads during asset bubbles," Review of Quantitative Finance and Accounting, Springer, vol. 56(1), pages 111-142, January.
  • Handle: RePEc:kap:rqfnac:v:56:y:2021:i:1:d:10.1007_s11156-020-00888-8
    DOI: 10.1007/s11156-020-00888-8
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    More about this item

    Keywords

    Securitization; MBS pricing; Credit ratings; Asset bubbles; Machine learning;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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