Vol. 16 No.4, 2018
Pengjie Gao, Paul Schultz and Zhaogang Song
Investors can trade individual agency mortgage-backed securities (MBS) as specified pools (SPs), or trade them through TBA forward contracts. Sellers in the TBA market deliver the cheapest possible pool that fulfills the contracts, so they are traded on a cheapest to deliver basis. More valuable mortgage-backed securities are traded as SPs. We show that trading costs are far, far lower for TBA trades. Trading costs are lower for large trades, for trades with more active dealers, for trades of MBS with a large balance outstanding, and for trades where dealers act as brokers rather than commit capital.