The Effect of Mortgage Price and Default Risk on Mortgage Spreads

The Effect of Mortgage Price and Default Risk on Mortgage Spreads 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Real Estate Finance and Economics Springer Journals

The Effect of Mortgage Price and Default Risk on Mortgage Spreads

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2005 by Springer Science + Business Media, Inc.
Subject
Economics; Regional/Spatial Science; Financial Services
ISSN
0895-5638
eISSN
1573-045X
D.O.I.
10.1007/s11146-005-6408-9
Publisher site
See Article on Publisher Site

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.

Journal

The Journal of Real Estate Finance and EconomicsSpringer Journals

Published: Apr 20, 2005

References

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