The Evolution of Mortgage Yield Concepts

Jack M. Guttentag

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper traces the evolution of the concept of "mortgage yield", starting with the yield to prepayment which held sway until the mid-seventies, to the cash flow yield which dominated until the late eighties, to the option adjusted yield which is intellectually dominant today. It is argued that while each of these concepts represented an improvement over the one that preceded it, the cash flow yield should have given way to the holding period yield, and then to an option adjusted holding period yield of which the (currently fashionable) option adjusted yield is merely a special case. The holding period yield is the ideal tool for scenario analysis because of its sensitivity to the particular circumstances of the user, and the option adjusted variant provides better information about whether a security is correctly priced because it does not prejudge the market’s consensus holding period.

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