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Prepayment Risk and Expected MBS Returns

Peter Diep, Andrea Eisfeldt and Scott Richardson

No 22851, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns in which MBS earn risk premia as compensation for their exposure to prepayment risk. We measure prepayment risk and estimate security risk loadings using real data on prepayment forecasts vs. realizations. Estimated loadings are monotonic in securities' coupons relative to the par coupon, as predicted by the model. Prepayment risks appear to be priced by specialized MBS investors. In particular, we find convincing evidence that prepayment risk prices change sign over time with the sign of a representative MBS investor's exposure to prepayment risk.

JEL-codes: E02 G12 G2 (search for similar items in EconPapers)
Date: 2016-11
New Economics Papers: this item is included in nep-mac, nep-rmg and nep-ure
Note: AP CF EFG
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