The predictive strength of MBS yield spreads during asset bubbles

Solomon Y. Deku, Alper Kara, Artur Semeyutin

Research output: Contribution to journalArticle

Abstract

We examine whether the predictive power of initial yield spreads of mortgage-backed securities (MBS) vary with the financial cycle. Using a cross-country sample of 4,203 MBS, we find that initial yield spreads of MBS incorporate more information than credit ratings and predict future downgrades, even after conditioning on initial credit ratings. Predictive power of spreads is higher during credit and housing bubbles and for the least risky AAA-rated MBS. We find that initial yield spreads capture the magnitude of rating downgrades, especially during asset bubble periods. As a novel approach in this literature, we also utilise machine learning techniques (regression trees, naïve Bayes, support vector machines and random forests) to confirm our results.
Original languageEnglish
Number of pages32
JournalReview of Quantitative Finance and Accounting
Early online date29 Apr 2020
DOIs
Publication statusE-pub ahead of print - 29 Apr 2020

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