The Market View of Mortgage Credit Risk

Prices of GSE Credit Risk Transfer (CRT) bonds, which amount to catastrophe bonds on underlying mortgage collateral, are informative about the market price of credit risk for conforming mortgage loans. I analyze the information content of this new asset class, which holds effectively half of the default risk of the $12 trillion US mortgage market. I build a pricing model and extract default probabilities from a comprehensive hand-collected dataset on CRT bond issuances using TRACE pricing data. I find that while the guaranty-fee (g-fee) implied by early CRT issuances was high and near the level charged by the GSEs (30-35 bp), the market has stabilized in recent years and implied g-fees have fallen significantly to around 10-20 basis points. I discuss the implications of these findings for several facets of the mortgage market