MSR Valuation and Risk Management
MIAC’s Dan Libby joined the Chrisman Commentary Daily Mortgage News Podcast to discuss what nearly two decades of MSR pricing history can tell us about valuation, portfolio construction, stress analysis and hedging effectiveness.
The Same Mortgage Rate Does Not Necessarily Mean the Same MSR Value
MIAC’s MSR pricing history shows periods when mortgage rates returned to similar levels, but MSR prices did not return to the same price levels. The relationships between mortgage rates and MSR valuation have also changed across different market environments.
Dan Libby, Head of Hedging and Funding Services at MIAC Analytics, recently joined the Chrisman Commentary Daily Mortgage News Podcast to discuss research using MIAC’s proprietary current coupon MSR price histories, including new issue and secondary pricing, going back to before the 2008 financial crisis.
The discussion examined what has historically driven MSR prices, how those relationships have changed across market regimes and what the analysis can tell us about valuation, portfolio construction, stress analysis and hedging.
“The same mortgage rate does not necessarily mean the same MSR value.”
Why Market Regimes Matter
Primary mortgage market rates are an important long-run valuation factor, but their relationship to MSR prices changes across market environments.
For the analysis discussed on the podcast, Dan divided MIAC’s long-dated pricing history into eight distinct market regimes, beginning with the financial crisis and continuing through periods including QE1, QE2 and HARP, the taper tantrum and today’s higher-for-longer environment.
Across those regimes, different factors have influenced mortgage valuation and risk. At times, the mortgage rate itself dominated. At others, Federal Reserve intervention, refinance behavior, liquidity, the mortgage basis, the shape of the curve and other factors played a greater role.
For portfolio construction and risk management, the implication is important: historical relationships are not necessarily stable. A hedge or stress relationship calibrated during one regime may behave differently when the market transitions into another.
Valuation and Risk Are Related, but They Are Not the Same Question
One of the distinctions highlighted in the analysis is the difference between explaining the level of MSR valuation and explaining how MSR prices move.
Valuation Level
In today’s higher-for-longer environment, the traditional rate and spread variables used in the analysis explain remarkably little of the level of conventional bulk MSR valuation.
Price Movement and Risk
When the analysis shifts from absolute valuation levels to month-to-month price changes, those underlying factors continue to explain a high percentage of price movements.
As Dan explained, a model can have difficulty telling you exactly what an MSR’s price should be while still doing a reasonably good job of describing how that MSR may respond to changes in rates or spreads.
Why Historical Analysis Still Matters
Forward-looking valuation frameworks tell us what an asset may do in the future under a particular set of assumptions. Historical analysis provides another perspective by showing what similar assets actually did when markets became stressed or assumptions broke down.
Dan described the historical work as another lens on the same asset, not a replacement for valuation and forward-looking models, but a way of challenging them.
Portfolio Construction
The historical work provides a broader range of realized valuation and risk relationships than can be observed from the relatively short history of an individual portfolio.
Stress Testing
Historical experience can also inform how stresses and scenarios are constructed. Instead of asking only what happens if rates rally 100 basis points, the analysis can consider what happened historically when rates rallied alongside changes in other market conditions, including:
- The shape of the yield curve
- The mortgage basis
- Primary mortgage spreads
- Liquidity conditions
The purpose is not to assume that history will repeat itself. It is to use historical experience to inform forward-looking stress and scenario analysis.
“Valuation uncertainty does not necessarily mean hedge ineffectiveness.”
Hedging Requires Robustness, Not False Precision
For hedging, Dan described the lesson as being more about humility and less about precision.
Rather than needing to know an MSR’s “true” duration to two decimal places, the objective is a hedge that is:
- Directionally right
- Robust across plausible environments
- Sized within a risk tolerance that recognizes model uncertainty
Dan also discussed comparing long-dated realized risk sensitivities with forward-looking durations from OES models. Where the two agree, that provides confidence. Where they disagree, it provides a reason to ask more questions.
In that framework, historical analysis does not replace forward-looking valuation models. It provides another way to challenge them and understand what may sit outside the model.
What Market Participants Should Watch
History does not tell us what will bring the current market regime to an end.
Looking across previous regimes, the catalysts for change have differed. Dan pointed to large shifts in rates and changes in participant involvement as factors to watch in the current environment, while noting that regime changes are often easier to identify in the rearview mirror than in advance.
The broader lesson from the research is that MSRs are highly regime dependent. Mortgage rates matter enormously to MSR values, but the transmission mechanism can change as Treasury rates, the mortgage basis, the curve, liquidity and other factors take on different roles.
“Models tell us what we expect should happen. Markets tell us what did happen, and good risk management requires paying close attention to both.”
Listen to the Chrisman Commentary Interview
Hear Dan Libby discuss the long-term drivers of MSR value, portfolio construction, stress analysis and hedging effectiveness.
Frequently Asked Questions
MIAC’s historical analysis found that the relationship between primary mortgage market rates and MSR prices changes across market regimes. Treasury rates, the shape of the curve, secondary mortgage spreads and primary-secondary spreads can help explain why apparently similar mortgage rate environments produce different MSR valuations.
The analysis divides MIAC’s pricing history into eight different economic and market environments. These include periods such as the financial crisis, QE1, QE2 and HARP, the taper tantrum and today’s higher-for-longer environment. Different factors can influence mortgage valuation and risk across these periods.
No. Dan’s analysis found that the risk relationships appear materially more stable in today’s market than the valuation relationships. A model may have difficulty explaining exactly what an MSR’s price should be while still providing useful information about how the asset responds to changes in rates or spreads.
Historical analysis can show how MSRs behaved when several market conditions changed together. Dan discussed using that history to inform scenarios that consider not only rate movements, but also changes in the curve, mortgage basis, primary mortgage spreads and liquidity conditions.
The historical work is not intended to replace forward-looking valuation models. Dan described it as another lens on the same asset that can help challenge forward-looking assumptions and provide context for how MSRs actually behaved in different market environments.
Continue the MSR Hedging Conversation
Connect with Dan Libby and MIAC to discuss MSR hedging and risk management.
About Dan Libby
Dan Libby is Head of Hedging and Funding Services at MIAC Analytics. His experience spans mortgage research, structured transactions, fixed-income investing and risk management.