Mortgage-Backed Securities and Securitization: Overview

Mortgage-backed securities (MBS) are the most important application of securitization — the process of pooling cash-flow-generating assets and issuing claims on the pool. The mortgage market is the largest fixed-income market in the United States, and MBS constitute a substantial fraction of the Bloomberg Aggregate Bond Index. Understanding MBS requires integrating ideas from bond mathematics, optionality, and structured finance: a mortgage borrower holds an implicit prepayment option (they can refinance at any time), and this option makes MBS behave differently from ordinary bonds — they exhibit negative convexity (their duration falls when rates fall, because prepayments accelerate). The challenge of MBS analysis is modelling this prepayment behaviour, which depends on interest rates, seasonality, economic conditions, and borrower demographics.