The impact of basis risk on the hedging of mortgage-backed securities with US treasury futures

Abstract

Mortgage-backed securities (MBS) are similar to traditional fixed-income securities in that they are exposed to interest rate risk. Interest rate risk involves potential losses in value stemming from unfavorable movements of interest rates. There are standard practices that allow investors to measure interest rate exposure and manage this risk by hedging, or reducing the risk, with positions in financial derivative securities. Interest rate hedges do not always work perfectly because of basis risk. Basis risk arises because the movement in an asset's price (MBS) is not perfectly correlated with the movement of the price of the derivatives (Treasury futures) used to hedge interest rate risk. The paper hypothesizes that despite the presence of basis risk, a dynamic hedging strategy using US Treasury futures makes a good hedge for MBS price fluctuations caused by interest rates. Empirical tests reject this hypothesis.

Notes

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Thesis Completion

1999

Semester

Summer

Advisor

Gilkeson, James H.

Degree

Bachelor of Science (B.S.)

College

College of Business Administration

Degree Program

Finance

Subjects

Business Administration -- Dissertations, Academic;Dissertations, Academic -- Business Administration;Interest rates -- Management

Format

Print

Identifier

DP0021578

Language

English

Access Status

Open Access

Length of Campus-only Access

None

Document Type

Honors in the Major Thesis

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