That's the million dollar question, right? Well the Lehman Agg is composed of ~40% mortgages, which currently have an OAS of roughly 150 bps (duration estimated at ~5 years). The spread between 5 and 7 year Treasuries is ~40 bps. ~40 bps * ~40% = 16 bps (ignoring optionality of corporate bonds). So lets say 16 bps from the optionality of mortgages. In other words, in my opinion... not much.
How does the spread look if you change the option pricing, say by assuming that prepayment rates will decline 50% from historic rates?
ReplyDeleteThat's the million dollar question, right? Well the Lehman Agg is composed of ~40% mortgages, which currently have an OAS of roughly 150 bps (duration estimated at ~5 years). The spread between 5 and 7 year Treasuries is ~40 bps. ~40 bps * ~40% = 16 bps (ignoring optionality of corporate bonds). So lets say 16 bps from the optionality of mortgages. In other words, in my opinion... not much.
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