Does Mortgage Hedging Raise Long-Term Interest Rate Volatility?

An examination of the impact of mortgage hedging activities on interest rate volatility considers a wide range of interest rate derivatives to isolate the sources that might be contributing to volatility. Over a rolling window providing estimates of key parameters, the measured effects of mortgage hedging on volatility are distorted by two outlier episodes: the collapse of Long-Term Capital Management, and the market reaction in the aftermath of the September 2001 events. Eliminating these episodes from the data shows that hedging appears to stabilize rate volatility over some periods while exacerbating it in others. The conclusion: that no simple relationship between hedging and rate volatility is clear.