Staff Reports
Asset Pricing with Cohort-Based Trading in MBS Markets
Number 931
July 2020

JEL classification: E58, G12, G18, G21

Authors: Nicola Fusari, Wei Li, Haoyang Liu, and Zhaogang Song

Agency mortgage-backed securities (MBS) with diverse characteristics are traded in parallel with individualized contracts in the specified pool (SP) market and with standardized contracts in the to-be-announced (TBA) market. We find that this unique parallel trading environment substantially affects MBS returns: (1) Greater heterogeneity in MBS values increases the yields of all MBS because it exacerbates the cheapest-to-deliver concerns for TBA buyers and reduces the value of the TBA market as a backup selling venue for SP buyers; (2) high selling pressure amplifies the impact of MBS heterogeneity on MBS yields; (3) greater MBS heterogeneity dampens trading activities on both the SP and TBA markets and increases the ratio between the two. We provide strong evidence that these effects differ from the impacts of prepayment risks.

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AUTHOR DISCLOSURE STATEMENT(S)
Nicola Fusari
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Wei Li
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

Haoyang Liu
The author (Haoyang Liu) declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Zhaogang Song
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.