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Funding Liquidity Risk and the Cross-section of MBS Returns

Yuriy Kitsul and Marcelo Ochoa

No 2016-052, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)

Abstract: This paper shows that funding liquidity risk is priced in the cross-section of excess returns on agency mortgage-backed securities (MBS). We derive a measure of funding liquidity risk from dollar-roll implied financing rates (IFRs), which reflect security-level costs of financing positions in the MBS market. We show that factors representing higher net MBS supply are generally associated with higher IFRs, or higher funding costs. In addition, we find that exposure to systematic funding liquidity shocks embedded in the IFRs is compensated in the cross-section of expected excess returns| agency MBS that are better hedges to funding liquidity shocks on average deliver lower excess returns-and that these premiums are separate from the premiums associated with prepayment risks.

Keywords: Agency mortgage-backed securities; Dollar rolls; Implied financing rates; Liquidity; Expected returns; Large Scale Asset Purchase programs (search for similar items in EconPapers)
JEL-codes: G1 G12 G19 E43 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2016-06-07
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DOI: 10.17016/FEDS.2016.052

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