Blog posts by Yihai Yu
Will U.S. homeowners slow down the heady prepayment rate on their mortgages — even if interest rates remain unchanged, thus potentially harming returns of mortgage-backed securities (MBS) and extending the duration of these securities?
Bond investors lost $1 trillion during “the great bond massacre”1 of 1994, which was triggered by the Federal Reserve’s aggressive tightening of interest rates. Many U.S. mortgage-backed securities (MBS) investors and broker-dealers misjudged the risk that fixed-rate prime mortgage borrowers would defer prepayments due to market conditions. This risk — known as “extension risk” — means that borrowers may hold onto mortgages longer than previously expected.