University of Washington Business School - Assistant Professor of Finance
Mortgage-backed securities (MBS) form the largest asset class of the U.S. fixed income market. Despite its size, little academic research has been conducted to investigate the effects of the MBS related hedging flows on other segments of the fixed income universe. This paper proposes a term structure model that takes these effects into account. The model is used to study the relationship between swaption prices and mortgage refinancing activity. A calibration of the proposed model implies that some of the previously documented mispricings in the swaption market may reflect a missing factor in term structure models related to the mortgage refinancing activity. Overall, this calibration exercise indicates that term structure models that incorporate information about the MBS universe may explain the returns of fixed income securities better than models that do not include MBS information.