Mortgage risk and the yield curve. Aytek Malkhozov, Philippe Mueller, Andrea Vedolin and Gyuri VenterWorking. Papers No 532. December 2015. Bank for International Settlements.
“We study the feedback from the risk of outstanding mortgage-backed securities (MBS) on the level and volatility of interest rates. We incorporate the supply shocks resulting from changes in MBS duration into a parsimonious equilibrium dynamic term structure model and derive three predictions that are strongly supported in the data: (i) MBS duration positively predicts nominal and real excess bond returns, especially for longer maturities; (ii) the predictive power of MBS duration is transitory in nature; and (iii) MBS convexity increases interest rate volatility, and this effect has a hump-shaped term structure.”