Abstract
Agency mortgage-backed securities (MBSs) are traded via both individual-asset-based specified pool (SP) contracts and cohort-based to-be-announced (TBA) contracts, which allow for the delivery of heterogeneous MBSs at a uniform price. We theoretically derive and empirically document the economic effects of cohort trading on issuers' security design: (1) Low-value and high-value loans are securitized into separate groups of MBSs sold in TBA and SP markets respectively; (2) issuers pool low-value loans together into TBA MBSs, consistent with arbitrary packaging practices based on the uniform TBA pricing; (3) issuers separate distinct high-value loans into multiple SP MBSs, suggesting that SP selling revenue exhibits a certain degree of convexity in MBS value; and (4) large issuers take more advantage of security design than small issuers do. Finally, we quantify the economic benefits of strategic security design to issuers to be 3 basis points in price, about 36% of the transaction costs for SP MBSs.
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