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

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  • Roberto Perli
  • Brian P. 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.

Suggested Citation

  • Roberto Perli & Brian P. Sack, 2003. "Does mortgage hedging amplify movements in long-term interest rates?," Finance and Economics Discussion Series 2003-49, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2003-49
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    References listed on IDEAS

    as
    1. 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.
    2. Dwight Jaffee, 2003. "The Interest Rate Risk of Fannie Mae and Freddie Mac," Journal of Financial Services Research, Springer;Western Finance Association, vol. 24(1), pages 5-29, August.
    3. Julia D. Fernald & Frank M. Keane & Patricia C. Mosser, 1994. "Mortgage security hedging and the yield curve," Research Paper 9411, Federal Reserve Bank of New York.
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