hard · Asset-Backed Securities
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 has positive convexity because the government guarantee ensures that bonds appreciate more than Treasuries when rates fall.
- Both have near-zero convexity because they are both amortizing assets with fixed principal schedules.
- 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 has higher negative convexity because car loans have shorter maturities, causing faster principal return.
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