On the determinants of yield spreads between mortgage pass-through and Treasury securities

Abstract

Yield spreads between mortgage pass-through and U.S. Treasury securities may reflect differences in taxation, phenomena affecting relative supply and demand, and compensation for default, call, and marketability risks on mortgage instruments. Our research empirically models differences in yields between pass-throughs and comparable-maturity Treasuries. We find that interest-rate volatility and the term structure of rates, factors often cited in the mortgage pricing literature as affecting the mortgage call premium, are the primary determinants of movements in these spreads. Moreover, these effects have grown in importance in recent years as exercise of the prepayment option has increased. We also find evidence that liquidity and credit concerns affect the pricing of pass-through securities.As the mortgage-backed securities market has expanded, researchers in academia and on Wall Street have increasingly focused their attention on the pricing of mortgage securities relative to other investments. Determining the factors that affect the relative yield performance of pass-throughs holds obvious interest not only for those researchers but also for investors in mortgages and other credit market instruments. Evaluation of pass-through/Treasury spreads also has important implications for the pricing of mortgages in the primary market. Virtually all new government-insured mortgages are now packaged into pass-throughs guaranteed by the Government National Mortgage Association (GNMA), and most conventional home loans are sold into the secondary market as well. The increased reliance on the secondary market for mortgage funding coupled with the deregulation of interest rates at financial institutions have linked mortgage interest rates more closely to pass-through yields. Consequently, the price of mortgage credit relative to other types of financing will depend largely on changes in secondary market spreads.

The Effects of Securitization on Consumer Mortgage Costs

“…They conclude the decline in secondary-market spreads implies a reduction in the costs of FHA mortgage loans. In contrast to Black, Garbade and Silber (1981), Rothberg, Nothaft and Gabriel (1989) find no relation between passthrough creation and the GNMA-Treasury spread, although investors demanded a liquidity premium on GNMA passthroughs in the early years of securitization. Likewise, in the conventional mortgage market, Rothberg, Nothaft and Gabriel (1989) find no relation between FHLMC passthrough yield spreads and securitization activity.…”

“…We are interested in longrun effects and seek to address the stationarity issues raised by Kolari, Fraser and Anari (1998) by searching for co-integrating relations among the nonstationary time series. Like Rothberg, Nothaft and Gabriel (1989), we believe the prepayment option is a significant determinant of mortgage spreads. We consult the option pricing literature for variables that proxy for prepayment and interest-rate risks.…”

“…Our approach is similar to Black, Garbade and Silber (1981) and Rothberg, Nothaft and Gabriel (1989).…”

Putting the squeeze on a market for lemons: Government-sponsored mortgage securitization

“…However, many market participants view explicitly government-insured mortgages (ones issued by Ginnie Mac) as even more valuable. For a description of this tiering, see Rothberg, Nothaft, and Gabriel (1989). 13.…”

Commercial Mortgage‐Backed Securities

“…The method of analysis is similar to that of Rothberg, et al (1989), which identifies various factors that influence the spread between yields on single-family mortgage-backed securities and U.S. Treasury securities. Among the factors they considered are credit (default) risk, prepayment risk, marketability (liquidity), and tax considerations.…”