Modeling the Dynamics of MBS Spreads

Abstract

This article investigates the dynamics of mean reversion and volatility in mortgage-backed security spreads, the yield spreads between conventional 30-year mortgages and Treasury securities. The findings indicate that changes in MBS spreads follow in all instances asymmetric mean-reverting processes. They exhibit non-stationary behavior following spread increases, but they are strongly mean-reverting following spread decreases. The mean-reverting component is statistically and economically stronger, thus offsetting non-stationarity. Volatility is time-varying, depending on past innovations, past volatility estimates, and the level of past spreads. Its behavior is asymmetric, rising more in response to positive innovations.