Journal of Real Estate Finance and Economics, 25:2/3, 173±195, 2002
# 2002 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Effects of Purchases of Mortgages and
Securitization by Government Sponsored Enterprises
on Mortgage Yield Spreads and Volatility
University of Florida, Warrington College of Business, Department of Finance, Insurance, and Real Estate,
321 Stuzin Hall, P.O. Box 117168, Gainesville, FL 32611-7168, U.S.A.
First Manhattan Consulting Group, 90 Park Avenue, New York, NY 10016, U.S.A.
In this paper, we investigate the effects of GSE (government sponsored enterprise) activities on mortgage yield
spreads and volatility. Using various regression procedures (i.e., vector error correction (VEC) and GARCH
models) and controlling for default and prepayment risk, we ®nd that securitizations and purchases of mortgages
by GSEs reduce mortgage yield spreads and volatility. In particular, we ®nd that the yield spread between
conforming and 10-year constant maturity treasury (CMT) rates decreases by 8.0 bp per $1billion increase in the
level of GSE securitizations. Similarly, if GSEs increase mortgage purchases, the yield spread decreases 10.5 bp
per $1billion increase of purchases. In addition, we hypothesize and ®nd that GSE activities have a spillover
effect to the non-conforming mortgage market; via investor substitutions, GSE purchases and securitizations of
conforming loans reduce non-conforming loan rates. Thus, the measured in¯uence of GSE activities is biased
downward when measured using the spread of non-conforming loans over conforming loan rates. We also ®nd
that purchases of mortgages by GSEs signi®cantly reduce mortgage yield volatility. In sum, our ®ndings show
that GSE activities reduce and stabilize mortgage market rates.
Key Words: mortgage rates, mortgage volatility, government sponsored enterprises, conforming vs. non-
conforming rates, vector error correction model, GARCH model
With total assets of several hundred billion dollars, the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Association (Freddie
Mac) are signi®cant participants in home mortgage markets. An ongoing question in the
real estate ®nance and economics literature, however, is what measurable effects do these
two government-sponsored enterprises (GSEs) have on mortgage markets? The answer to
this question has important implications for both mortgage market participants and for
current policy debates regarding the ef®cacy of GSEs.
In this paper, we address this
question by investigating the effects of purchases and securitizations of mortgages by the
GSEs on mortgage yield spreads and volatility. In particular, we employ OLS,
cointegration, and generalized autoregressive conditional heteroskedastic (GARCH)