Report

Asset Pricing with Cohort-Based Trading in MBS Markets


Abstract: Agency mortgage-backed securities (MBS) with diverse characteristics are traded in parallel with individualized contracts in the specified pool (SP) market and with standardized contracts in the to-be-announced (TBA) market. We find that this unique parallel trading environment substantially affects MBS returns: (1) Greater heterogeneity in MBS values increases the yields of all MBS because it exacerbates the cheapest-to-deliver concerns for TBA buyers and reduces the value of the TBA market as a backup selling venue for SP buyers; (2) high selling pressure amplifies the impact of MBS heterogeneity on MBS yields; (3) greater MBS heterogeneity dampens trading activities on both the SP and TBA markets and increases the ratio between the two. We provide strong evidence that these effects differ from the impacts of prepayment risks.

Keywords: cohort; heterogeneity; liquidity; MBS; prepayment; TBA;

JEL Classification: E58; G12; G18; G21;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2020-07-01

Number: 931

Note: Revised August 2020.