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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 Fernald & Patricia C. Mosser & Frank Keane, 1994. "Mortgage security hedging and the yield curve," Research Paper 9411, Federal Reserve Bank of New York.
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    Cited by:

    1. repec:eee:jbfina:v:82:y:2017:i:c:p:165-179 is not listed on IDEAS
    2. Hancock, Diana & Passmore, Wayne, 2011. "Did the Federal Reserve's MBS purchase program lower mortgage rates?," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 498-514.
    3. repec:pal:imfecr:v:65:y:2017:i:1:d:10.1057_s41308-016-0026-9 is not listed on IDEAS
    4. Sabrina Pellerin & Steven Sabol & John R. Walter, 2013. "mREITs and their risks," Working Paper 13-19, Federal Reserve Bank of Richmond.
    5. Wall, Larry D. & Eisenbeis, Robert A. & Frame, W. Scott, 2005. "Resolving large financial intermediaries: Banks versus housing enterprises," Journal of Financial Stability, Elsevier, vol. 1(3), pages 386-425, April.
    6. John M. Quigley, 2006. "Federal credit and insurance programs: housing," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 281-310.
    7. Andreas Lehnert & Wayne Passmore & Shane Sherlund, 2008. "GSEs, Mortgage Rates, and Secondary Market Activities," The Journal of Real Estate Finance and Economics, Springer, vol. 36(3), pages 343-363, April.
    8. Poitras, Geoffrey & Zanotti, Giovanna, 2016. "Mortgage contract design and systemic risk immunization," International Review of Financial Analysis, Elsevier, vol. 45(C), pages 320-331.
    9. W. Scott Frame & Lawrence J. White, 2005. "Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?," Journal of Economic Perspectives, American Economic Association, vol. 19(2), pages 159-184, Spring.
    10. Hancock Diana & Passmore Wayne, 2009. "Three Initiatives Enhancing the Mortgage Market and Promoting Financial Stability," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 9(3), pages 1-25, March.
    11. Angela Maddaloni & Darren Pain, 2004. "Corporate ‘excesses’ and financial market dynamics," Occasional Paper Series 17, European Central Bank.
    12. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2016. "Mortgage Risk and the Yield Curve," Review of Financial Studies, Society for Financial Studies, vol. 29(5), pages 1220-1253.
    13. Dietrich Domanski & Hyun Song Shin & Vladyslav Sushko, 2017. "The Hunt for Duration: Not Waving but Drowning?," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(1), pages 113-153, April.
    14. Beltratti, Andrea & Benetton, Matteo & Gavazza, Alessandro, 2017. "The role of prepayment penalties in mortgage loans," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 165-179.
    15. Feldhütter, Peter & Lando, David, 2008. "Decomposing swap spreads," Journal of Financial Economics, Elsevier, vol. 88(2), pages 375-405, May.
    16. Robert Eisenbeis & W. Frame & Larry Wall, 2007. "An Analysis of the Systemic Risks Posed by Fannie Mae and Freddie Mac and An Evaluation of the Policy Options for Reducing Those Risks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 31(2), pages 75-99, June.
    17. Sergey V. Chernenko, 2004. "The information content of forward and futures prices: market expectations and the price of risk," International Finance Discussion Papers 808, Board of Governors of the Federal Reserve System (U.S.).
    18. Hanson, Samuel G., 2014. "Mortgage convexity," Journal of Financial Economics, Elsevier, vol. 113(2), pages 270-299.

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    Keywords

    Mortgages ; Mortgage loans;

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