Using a vector autoregressive model with monthly data from 1988 through 2001, this study investigates the factors that drive the excess returns on a widely followed mortgage-backed securities (MBS) index. We find that eight important economic variables (industrial productions, new home sales, bond horizon premium, bond quality premium, mortgage rate, refinancing proxy, general stock market index and world bond market index) appear to move the excess returns on MBS. Impulse response analysis and variance decomposition further indicate a strong dynamic relationship between MBS excess returns and changes in these economic variables. Additional analysis of Freddie Mac and Fannie Mae MBS also indicates that the risk of the MBS guarantor is an important determinant of the MBS return dynamics after the creation of the Office of Federal Housing Enterprise Oversight. Copyright 2005 by the American Real Estate and Urban Economics Association
