medium · Asset-Backed Securities asset-nuances
Compare the 'Negative Convexity' risk of an Agency MBS pool to a Prime Auto ABS pool during a period of rapidly falling interest rates.
- Agency MBS exhibits positive convexity because the government guarantee ensures bond prices appreciate more sharply than comparable Treasuries when rates fall.
- Both securitizations exhibit near-zero convexity since they are structured as fully amortizing assets with fixed, contractually scheduled principal repayment terms overall.
- Agency MBS has much higher negative convexity because mortgage prepayments are highly interest-rate sensitive, while auto prepayments are driven by vehicle trade-ins.
- Auto ABS exhibits higher negative convexity than agency MBS because auto loans carry much shorter stated maturities, mechanically causing a faster return of principal to investors.
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