The Effect of Mortgage Price and Default Risk on Mortgage Spreads

James Kau () and Luke Peters ()

The Journal of Real Estate Finance and Economics, 2005, vol. 30, issue 3, 285-295

Abstract: Variations over time in mortgage yield spreads should reflect changes in the underlying prepayment option value; moreover, the relationship between mortgage yield spreads and interest rate dynamics should weaken as the value of the borrower’s prepayment option declines. We verify this hypothesis through an empirical analysis of residential mortgage yield spread behavior, and we also present evidence that the strength of the relationship between mortgage spreads and interest rate dynamics weakens (strengthens) as the level of default risk increases (decreases). This result is consistent with the “competing risks” effect between a borrower’s option to prepay or default. Our results demonstrate the importance of accounting for mortgage price discount to par as well as default risk when developing time series of mortgage yields. Copyright Springer Science + Business Media, Inc. 2005

Keywords: mortgage spreads; call option; points; yield curve dynamics (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (8)

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DOI: 10.1007/s11146-005-6408-9

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The Journal of Real Estate Finance and Economics is currently edited by Steven R. Grenadier, James B. Kau and C.F. Sirmans

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