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The Terminations Premium in Mortgage Coupon Rates: Evidence on the Integration of Mortgage and Bond Markets

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  • Patric H. Hendershott
  • Kevin E. Villani

Abstract

During the Last three years mortgage rates have risen relative to yields on comparable maturity bonds. The questions addressed in the present paper are what is the extent of this increase and to what is it attributable? We find the increase between early 198 and early 1981 in coupon rates on GNMA mortgage pools relative to ''the" rate on a comparable portfolio of Treasury bonds to be about 100 basis points. We attribute the increase to a rise in the terminations premia built into mortgage coupon rates. The premia is the price borrowers are charged for the option to repay the mortgage when it is to their benefit (to refinance if interest rates decline). This price has risen in response to an increase in interest rate uncertainty. Our empirical results suggest that the increase is due to both greater uncertainty regarding the inflation premium in interest rates and the lesser weight the monetary authorities give to interest rate stability in their deliberations.

Suggested Citation

  • Patric H. Hendershott & Kevin E. Villani, 1981. "The Terminations Premium in Mortgage Coupon Rates: Evidence on the Integration of Mortgage and Bond Markets," NBER Working Papers 0738, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0738
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    References listed on IDEAS

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    1. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-282, June.
    2. George G. Kaufman & George E. Morgan, 1980. "Standardizing Yields on Mortgages and other Securities," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 8(2), pages 163-179, June.
    3. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-830, June.
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    Cited by:

    1. Patric H. Hendershott & Sheng Cheng Hu, 1981. "Accelerating Inflation, Nonassumable Fixed-Rate Mortgages, and Consumer Choice and Welfare," NBER Working Papers 0755, National Bureau of Economic Research, Inc.
    2. Patric H. Hendershott & Sheng Hu, 1982. "Accelerating Inflation and Nonassumable Fixed-Rate Mortgages: Effects On Consumer Choice and Welfare," Public Finance Review, , vol. 10(2), pages 158-184, April.
    3. Ben Iben & Randall Pozdena, 1984. "Pricing mortgages: an options approach," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 39-55.
    4. Patric H. Hendershott & Robert Van Order, 1987. "Pricing Mortgages: An Interpretation of the Models and Results," NBER Working Papers 2290, National Bureau of Economic Research, Inc.

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