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MBS and Negative Duration

Posted: November 8th, 2018, 4:24 pm
by CaffeineLover
I understand why IOs have negative duration and why POs have positive duration.

I know that CMOs can have either positive or negative durations, but I don't know why.

What are the conditions for a CMO to have negative duration?  What is the economic explanation for why a CMO duration becomes negative?

Re: MBS and Negative Duration

Posted: November 9th, 2018, 2:59 pm
by Alan
Not my area, but the simple answer would be to see if you can characterize a particular tranche as, roughly, "IO-like", "PO-like", or "bond-like". The ones that are more IO-like may have negative duration for the reason you say you understand: rates go up, prepays slow, and you get more cash. More cash dominates discounting known cash. 

The other two general types should have positive duration, as discounting is the dominant effect. There are a zillion variations, so analyzing a particular issue's structure might take a fair amount of work (and guess-work). I have never done this, so can't help you with the details.