Duration of MBS

[jcjc0602]

Hi, everybody

A rise in interest rates will reduce the prepayment and therefore increase duration of a MBS.

How to understand this?

My thought is that if the rates are low this statement is true since the negative convexity of MBS is becoming less significant with less prepayment. However, when rates are high, it behaves like a regular bond. if rate increases, the duration will decrease.

 

[ShaktiRathore]

Avoid getting into technicality and just see my reasoning:
As interest rate increase, the mortgage holders will not refinance the mortgage at higher interest rate as they if refinance again will have to refinance the mortgage at a higher interest rate and hence they keep on paying their Monthly payments with no prepayment.IN this way longer it will take to repay the loan and thus the duration of MBS increases. On the other hand if interest rate decreases the mortgage holders will refinance the mortgage at lower interest rate by first selling the home than making the prepayment and than again financing the mortgage at a lower interest rate. In this way the homeowners locked the profit due to rising home prices and at the same time refinancing loan at lower rate than before. Thus prepayment increases with lowering of interest rates.Thus lowering the time/duration of loan.

thanks

 

[jcjc0602]

Avoid getting into technicality and just see my reasoning:
As interest rate increase, the mortgage holders will not refinance the mortgage at higher interest rate as they if refinance again will have to refinance the mortgage at a higher interest rate and hence they keep on paying their Monthly payments with no prepayment.IN this way longer it will take to repay the loan and thus the duration of MBS increases. On the other hand if interest rate decreases the mortgage holders will refinance the mortgage at lower interest rate by first selling the home than making the prepayment and than again financing the mortgage at a lower interest rate. In this way the homeowners locked the profit due to rising home prices and at the same time refinancing loan at lower rate than before. Thus prepayment increases with lowering of interest rates.Thus lowering the time/duration of loan.

thanks

Yes, that makes sense. Thanks!