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I’m just going to talk about fixed-rate US agencies. Treasuries are option-free, while fixed rate mortgages include a prepayment option. Also, these mortgages h
by blake1 4y ago
I’m just going to talk about fixed-rate US agencies. Treasuries are option-free, while fixed rate mortgages include a prepayment option. Also, these mortgages have a strong implicit backing of the US Government, so there is no default risk.
The article is about a spread, so the risk-free and interest-rate-volatility terms will be shared with a treasury.
The dynamics of that prepayment risk are complex, and there is a vast literature on the subject. This article simplifies it enormously, based on my experience in this field.
- snake_doc 4y agoYes, absolutely right no argument there. Intuitively, prepayment risk can be broken down into interest rate risk and default risk in its most basic terms when compared to a coupon bond. The risk relates to duration and cash flows. Early prepayments decrease duration, and decrease expected cash flows, which can be thought of in relation to interest rate risk and default risk. I guess I prefer when complex topics are broken down back to their principal parts.