AQR Capital Management
Institutional Affiliations: AQR Capital Management and London Business School
NBER Working Papers and Publications
|November 2016||Prepayment Risk and Expected MBS Returns|
with Peter Diep, Andrea L. Eisfeldt: w22851
We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns in which MBS earn risk premia as compensation for their exposure to prepayment risk. We measure prepayment risk and estimate security risk loadings using real data on prepayment forecasts vs. realizations. Estimated loadings are monotonic in securities' coupons relative to the par coupon, as predicted by the model. Prepayment risks appear to be priced by specialized MBS investors. In particular, we find convincing evidence that prepayment risk prices change sign over time with the sign of a representative MBS investor's exposure to prepayment risk.