Mean Reversions in GNMA Returns

Christopher K. Ma

Real Estate Economics, 1990, vol. 18, issue 2, 207-226

Abstract: The random‐walk hypothesis is tested in the prices of mortgage‐backed securities traded in the secondary market. Using the variance ratio test, the random‐walk hypothesis is rejected for the daily GNMA bond return. We identify two components in the return series: a systematic component reflecting the market pricing on the expected information, and a noise term that represents the pricing on the unexpected information. After adjusting for the impact of bid‐ask spread and thin trading on the price quotations, the evidence suggests that the short‐horizon, weekly realized return, being dominated by the negative serial correlation of the random component, exhibits a mean‐reverting process. However, it is also found that the noise term demonstrates significant positive serial correlation for holding periods of over two weeks. Thus, for longer‐term returns, the realized return exhibits positive dependence. The implication is that the price of GNMA bonds did not react to unexpected information in a rational fashion in that the adjustment process is not instantaneous.

Date: 1990
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