PRICING MORTGAGE-BACKED SECURITIES IN A MULTIFACTOR INTEREST-RATE ENVIRONMENT - A MULTIVARIATE DENSITY-ESTIMATION APPROACH

Multivariate density estimation (MDE) suggests that mortgage-backed se curity (MBS) prices can be well described as a function of the level a nd slope of the term structure. We analyze how this function varies ac ross MBSs with different coupons. An important finding is that the int erest rate level proxies for the moneyness of the option, the expected level of prepayments, and the average life of the cash flours, while the term structure slope controls for the average rate at which these cash flouts should be discounted. Through the origination and prepayme nt behavior of mortgages differ substantially across coupons, there re mains an unexplained common factor in MBS prices. This factor noes not seem to be related to the usual suspects and therefore Presents a puz zle to financial economists.