Research and publications
The Three-Factor Hedging Strategy for Mortgage Pass-Through Securities: Empirical Evidence
The Journal of Fixed Income, Winter 2019, Vol. 28 N° 3 pp. 55 - 67
The mortgage pass-through securities sector of the investment-grade bond market is attractive to institutional ...
Author(s):
Emory E. Ruscus, Frank J. Fabozzi, Glenn Schultz
Summary:
The Journal of Fixed Income, Winter 2019, Vol. 28 N° 3 pp. 55 - 67
The mortgage pass-through securities sector of the investment-grade bond market is attractive to institutional investors seeking to outperform a bond index without taking a view on credit risk. Market participants view this sector as being less price efficient than the other investment-grade bonds sectors, offering opportunities within the sector to take contrary positions relative to prevailing prices, particularly with respect to future prepayments. In executing a relative value strategy to enhance returns in this sector, portfolio managers must be able to remove interest rate risk. Unlike hedging interest rate risk in the other sectors of the investmentgrade bond market, the cash flow structure of mortgage pass-throughs is such that there is interest rate exposure, via prepayment rates, due to a change in the term structure of interest rate. Both academics and practitioners have proposed several strategies for hedging interest rate risk. In this article we evaluate a three-factor hedging strategy for agency pass-throughs, comparing the performance of this strategy to both the single-factor and twofactor hedging strategies. Our analysis finds that under certain conditions the three-factor hedging strategy outperforms both the one- or two-factor hedging strategy.
| Type : | Academic Publication |
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| Date : | 07/01/2019 |
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