It’s a Tricky Challenge in the $8 Trillion Mortgage-Backed Securities Market
In a paper published in the Review of Financial Studies, UCLA Anderson’s Mikhail Chernov, Brett R. Dunn, a Ph.D. student, and Francis Longstaff developed a model based on a cross section of all MBS to explore the market’s pricing-in of prepayment risk, and what factors beyond interest rates are responsible for the prepayment risk premium. They also then discuss why there is a significant gap between implied and actual prepayment rates.
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