Response of Subprime Residential Mortgage Loan and Mortgage-Backed Securities Prices to Financial Shocks

J. Mukuddem-Petersen, M.A. Petersen, T. Bosch, and D. De Waal (S. Africa)

Keywords

Subprime Mortgage Crisis (SMC); Residential Mortgage Loan (RML); Residential Mortgaged-Backed Securities (RMBSs); Vector Autoregressive Model (VAR); General ized Impulse Response Function (GIRF).

Abstract

This paper addresses the impact of speculative mortgage funding on the pricing of residential mortgage loans and their securitization into residential mortgage-backed secu rities in a subprime context. In this regard, we make use of techniques involving multivariate vector autoregressive models and generalized impulse response functions in or der to study the shocks related to this type of funding. In particular, the vector autoregressive model utilized in this paper estimates individual regressions within a sys tem where all economic variables are endogenously deter mined. Furthermore, the aforementioned response func tions provide a means of determining the impact of shocks within a given horizon. For mortgage loans, these shocks primarily involve interest rates, mortgagor risk character istics and loan terms while for mortgage-backed securi ties the shock mainly emanates from the prepayment rate. Our ļ¬ndings indicate that speculative mortgage funding has driven up the prices of subprime residential mortgage loans and residential mortgage-backed securities. In addition, such funding contributes to increased volatility in related mortgage markets.

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