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Does Prepayment Risk of Mortgages Affect Excess Returns of Bank Stocks?

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  • Ling T He

Abstract

This paper explores the relationship between the prepayment risk embedded in conventional, fixed-rate residential mortgages and excess returns for bank stocks. There are two interesting findings in this study. First, commercial banks traded in the Nasdaq market are more meanvariance efficient than the other seven groups of industrial stocks. Second, the prepayment risk factor is significant for these banks. The prepayment risk mainly reflects a call option embedded in a mortgage plus foreclosure costs associated with a mortgage put option. This risk is measured by a remaining part of mortgage rates after excluding the influence of real estate market, maturity, and default risks on mortgage rates. The results of this study suggest that the prepayment risk factor does significantly affect excess returns for bank stocks in the period with high levels of mortgage refinancing activities.Business Economics (2007) 42, 45–52; doi:10.2145/20070105

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  • Ling T He, 2007. "Does Prepayment Risk of Mortgages Affect Excess Returns of Bank Stocks?," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 42(1), pages 45-52, January.
    • Handle: RePEc:pal:buseco:v:42:y:2007:i:1:p:45-52
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    Cited by:

    1. Hamid Baghestani, 2008. "Consensus vs. Time‐series Forecasts of US 30‐year Home Mortgage Rates," Journal of Property Research, Taylor & Francis Journals, vol. 25(1), pages 45-60, January.

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